MSC Industrial Direct (NYSE:MSM) has had a great run on the share market with its stock up by a significant 13% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on MSC Industrial Direct's ROE.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for MSC Industrial Direct is:

18% = US$256m ÷ US$1.4b (Based on the trailing twelve months to August 2024).

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 $0.18 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of MSC Industrial Direct's Earnings Growth And 18% ROE

To begin with, MSC Industrial Direct seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 16%. Consequently, this likely laid the ground for the decent growth of 6.1% seen over the past five years by MSC Industrial Direct.

As a next step, we compared MSC Industrial Direct'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 23% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is MSM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is MSC Industrial Direct Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 55% (or a retention ratio of 45%) for MSC Industrial Direct suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, MSC Industrial Direct has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 72% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, it does look like MSC Industrial Direct has some positive aspects to its business. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.