Xylem (NYSE:XYL) has had a rough three months, with its share price down 6.1%. However, share prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In particular, we decided to examine Xylem’s return on equity in this article.
Return on equity (ROE) is a measure of how effectively a company increases its value and manages its investors’ money. In short, ROE shows the profit each dollar generates relative to its shareholders’ investments.
Check out our latest analysis for Xylem
How do you calculate return on equity?
ROE can be calculated using the following formula:
Return on equity = Net profit (from continuing operations) ÷ Equity
Based on the above formula, the ROE for Xylem is:
7.4% = $765 million ÷ $10 billion (based on the trailing twelve months to June 2024).
The “return” is the amount earned after taxes over the last twelve months. This means that for every dollar invested by its shareholders, the company earned $0.07 in profit.
What is the relationship between ROE and earnings growth?
So far we have learned that return on equity is a measure of a company’s profitability. Now we need to evaluate how much profit the company reinvests or “retains” for future growth, which then gives us an idea of the company’s growth potential. Generally speaking, all things being equal, companies with high return on equity and profit retention will have a higher growth rate than companies that do not have these characteristics.
A direct comparison of Xylem’s earnings growth and return on equity of 7.4%
At first glance, Xylem’s return on equity is not particularly noteworthy. A quick further investigation shows that the company’s return on equity does not compare well even to the industry average of 15%. However, we can see that Xylem has posted a modest net income growth of 9.4% over the past five years. So, there could be other aspects that are positively influencing the company’s earnings growth. For example, it is possible that the company’s management has made some good strategic decisions or that the company has a low payout ratio.
In the next step, we compared Xylem’s net income growth with that of the industry and found that the company has a similar growth rate compared to the industry average growth rate of 11% over the same period.
Earnings growth is an important yardstick when evaluating a stock. The investor should try to determine if the expected earnings growth or expected earnings decline, whichever may be the case, is priced in. This will then help them determine if the stock is positioned for a good or bad future. What is XYL worth today? The intrinsic value infographic in our free research report helps visualize if XYL is currently mispriced by the market.
Does Xylem use its retained earnings effectively?
With a three-year median payout ratio of 50% (meaning the company retains 50% of its earnings), Xylem appears to be reinvesting efficiently, allowing the company to post decent earnings growth and pay a well-covered dividend.
In addition, Xylem has been paying dividends for at least ten years, which shows that the company is committed to sharing its profits with its shareholders. Our latest analyst data shows that the company’s future payout ratio is expected to fall to 30% over the next three years. The fact that the company’s return on equity is expected to rise to 11% over the same period is explained by the decline in the payout ratio.
Summary
Overall, we feel that Xylem has some positive attributes. Despite its low ROE, the fact that the company reinvests a very high proportion of its profits into its business has undoubtedly contributed to its high earnings growth. As such, recent analyst forecasts show that the company will continue to see an increase in its earnings. You can find more information on the company’s future earnings growth forecasts here. free Read the company’s analyst forecasts report to learn more.
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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.
