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Element Solutions Inc's (NYSE:ESI) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

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Element Solutions (NYSE:ESI) has had a rough three months with its share price down 2.7%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Element Solutions' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Element Solutions

How Is ROE Calculated?

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 Element Solutions is:

9.2% = US$228m ÷ US$2.5b (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.09 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 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.

Element Solutions' Earnings Growth And 9.2% ROE

At first glance, Element Solutions' ROE doesn't look very promising. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Element Solutions grew its net income at a significant rate of 65% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

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 3.2% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for ESI? You can find out in our latest intrinsic value infographic research report.

Is Element Solutions Using Its Retained Earnings Effectively?

Element Solutions has a really low three-year median payout ratio of 16%, meaning that it has the remaining 84% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Along with seeing a growth in earnings, Element Solutions only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 9.9% over the next three years. The fact that the company's ROE is expected to rise to 17% over the same period is explained by the drop in the payout ratio.

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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.