Has Element Solutions Inc (NYSE:ESI) Stock's Recent Performance Got Anything to Do With Its Financial Health?
Element Solutions' (NYSE:ESI) stock up by 6.1% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, 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. Specifically, we decided to study Element Solutions' ROE in this article.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Element Solutions
How Is ROE Calculated?
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 Element Solutions is:
3.3% = US$77m ÷ US$2.3b (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.03 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
A Side By Side comparison of Element Solutions' Earnings Growth And 3.3% ROE
It is quite clear that Element Solutions' ROE is rather low. Even compared to the average industry ROE of 10%, the company's ROE is quite dismal. Despite this, surprisingly, Element Solutions saw an exceptional 60% net income growth over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
We then compared Element Solutions' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 5.3% in the same period.
Earnings growth is a huge factor in stock valuation. 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. Is Element Solutions fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Element Solutions Using Its Retained Earnings Effectively?
Element Solutions' three-year median payout ratio to shareholders is 16%, which is quite low. This implies that the company is retaining 84% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Our latest analyst data shows that the future payout ratio of the company is expected to drop to 9.6% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 13%, over the same period.
Summary
On the whole, we do feel that Element Solutions has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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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