Johnson Controls International plc's (NYSE:JCI) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?
Johnson Controls International’s (NYSE:JCI) stock is up by a considerable 15% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. In this article, we decided to focus on Johnson Controls International’s ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
Check out our latest analysis for Johnson Controls International
How To Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Johnson Controls International is:
4.3% = US$795m ÷ US$19b (Based on the trailing twelve months to September 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 $0.04 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Johnson Controls International’s Earnings Growth And 4.3% ROE
On the face of it, Johnson Controls International’s ROE is not much to talk about. Next, when compared to the average industry ROE of 16%, the company’s ROE leaves us feeling even less enthusiastic. Accordingly, Johnson Controls International’s low net income growth of 4.1% over the past five years can possibly be explained by the low ROE amongst other factors.
We then compared Johnson Controls International’s net income growth with the industry and found that the company’s growth figure is lower than the average industry growth rate of 8.3% in the same period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Johnson Controls International is trading on a high P/E or a low P/E, relative to its industry.
Is Johnson Controls International Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 77% (or a retention ratio of 23%), most of Johnson Controls International’s profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.
Moreover, Johnson Controls International 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. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 41% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 12%, over the same period.
Conclusion
Overall, we would be extremely cautious before making any decision on Johnson Controls International. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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