Johnson Controls International (NYSE:JCI) has had a great run on the share market with its stock up by a significant 6.0% over the last week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Johnson Controls International's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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:

11% = US$1.8b ÷ US$17b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Johnson Controls International's Earnings Growth And 11% ROE

At first glance, Johnson Controls International seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 19% does temper our expectations. However, the moderate 14% net income growth seen by Johnson Controls International over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.

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 18% in the same 5-year 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Johnson Controls International's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Johnson Controls International Using Its Retained Earnings Effectively?

Johnson Controls International has a significant three-year median payout ratio of 59%, meaning that it is left with only 41% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Johnson Controls International is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 37% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Summary

In total, it does look like Johnson Controls International has some positive aspects to its business. While no doubt its earnings growth is pretty decent, we do feel that the reinvestment rate is pretty low. Meaning, the earnings growth number could have been significantly higher, had the company been retaining more of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.