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NewMarket's (NYSE:NEU) stock up by 3.6% over the past month. 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. In this article, we decided to focus on NewMarket'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 NewMarket is:
35% = US$254m ÷ US$724m (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.35 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. 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.
NewMarket's Earnings Growth And 35% ROE
To begin with, NewMarket has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 9.3% the company's ROE is quite impressive. Given the circumstances, we can't help but wonder why NewMarket saw little to no growth in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then compared NewMarket's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.8% in the same period, which is a bit concerning.
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. If you're wondering about NewMarket's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is NewMarket Efficiently Re-investing Its Profits?
Despite having a moderate three-year median payout ratio of 35% (meaning the company retains65% of profits) in the last three-year period, NewMarket's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Moreover, NewMarket has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
In total, it does look like NewMarket has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on NewMarket and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
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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