Terex (NYSE:TEX) has had a rough three months with its share price down 15%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Terex's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Terex is:

27% = US$496m ÷ US$1.8b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.27 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Terex's Earnings Growth And 27% ROE

First thing first, we like that Terex has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. So, the substantial 34% net income growth seen by Terex over the past five years isn't overly surprising.

As a next step, we compared Terex's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

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). 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 Terex is trading on a high P/E or a low P/E, relative to its industry.

Is Terex Efficiently Re-investing Its Profits?

Terex's three-year median payout ratio to shareholders is 11%, which is quite low. This implies that the company is retaining 89% of its profits. So it looks like Terex is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Terex has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 12% of its profits over the next three years. Regardless, Terex's ROE is speculated to decline to 19% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with Terex's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.