McCormick & Company, Incorporated's (NYSE:MKC) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?

Simply Wall St · 10/16 15:32

McCormick's (NYSE:MKC) stock up by 9.5% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on McCormick's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for McCormick

How Do You Calculate Return On Equity?

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 McCormick is:

15% = US$793m ÷ US$5.5b (Based on the trailing twelve months to August 2024).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.15.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

McCormick's Earnings Growth And 15% ROE

To start with, McCormick's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 13%. However, we are curious as to how McCormick's decent returns still resulted in flat growth for McCormick in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 8.2% over the last few years.

past-earnings-growth
NYSE:MKC Past Earnings Growth October 16th 2024

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is MKC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is McCormick Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 58% (meaning, the company retains only 42% of profits) for McCormick suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

In addition, McCormick has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 58%. As a result, McCormick's ROE is not expected to change by much either, which we inferred from the analyst estimate of 15% for future ROE.

Summary

Overall, we feel that McCormick certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.