Are Oil-Dri Corporation of America's (NYSE:ODC) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?
Oil-Dri Corporation of America (NYSE:ODC) has had a rough three months with its share price down 2.6%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Oil-Dri Corporation of America's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Oil-Dri Corporation of America
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 Oil-Dri Corporation of America is:
11% = US$17m ÷ US$147m (Based on the trailing twelve months to April 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.11 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Oil-Dri Corporation of America's Earnings Growth And 11% ROE
To begin with, Oil-Dri Corporation of America seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 24% does temper our expectations. Further, Oil-Dri Corporation of America's five year net income growth of 2.2% is on the lower side. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. Therefore, the low earnings growth could be the result of other factors. These include low earnings retention or poor capital allocation.
As a next step, we compared Oil-Dri Corporation of America's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 5.2% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Oil-Dri Corporation of America is trading on a high P/E or a low P/E, relative to its industry.
Is Oil-Dri Corporation of America Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 60% (that is, the company retains only 40% of its income) over the past three years for Oil-Dri Corporation of America suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Moreover, Oil-Dri Corporation of America has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
Summary
Overall, we have mixed feelings about Oil-Dri Corporation of America. On the one hand, the company does have a decent rate of return, however, its earnings growth number is quite disappointing and as discussed earlier, the low retained earnings is hampering the growth.
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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