It is hard to get excited after looking at Toll Brothers' (NYSE:TOL) recent performance, when its stock has declined 17% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Toll Brothers' ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Toll Brothers
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Toll Brothers is:
9.5% = US$450m ÷ US$4.7b (Based on the trailing twelve months to July 2020).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Toll Brothers' Earnings Growth And 9.5% ROE
At first glance, Toll Brothers' ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 16%. Although, we can see that Toll Brothers saw a modest net income growth of 11% over the past five years. We reckon that there could be other factors at play here. 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.
As a next step, we compared Toll Brothers' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Toll Brothers is trading on a high P/E or a low P/E, relative to its industry.
Is Toll Brothers Efficiently Re-investing Its Profits?
Toll Brothers' three-year median payout ratio to shareholders is 9.2% (implying that it retains 91% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Moreover, Toll Brothers is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 7.6%. Still, forecasts suggest that Toll Brothers' future ROE will rise to 13% even though the the company's payout ratio is not expected to change by much.
Summary
In total, it does look like Toll Brothers has some positive aspects to its business. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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