Valhi, Inc.'s (NYSE:VHI) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?
It is hard to get excited after looking at Valhi's (NYSE:VHI) recent performance, when its stock has declined 29% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Valhi's ROE in this article.
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.
View our latest analysis for Valhi
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 Valhi is:
6.9% = US$71m ÷ US$1.0b (Based on the trailing twelve months to March 2021).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.07.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Valhi's Earnings Growth And 6.9% ROE
At first glance, Valhi's ROE doesn't look very promising. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. Valhi was still able to see a decent net income growth of 8.6% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Valhi's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 3.8%.
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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Valhi is trading on a high P/E or a low P/E, relative to its industry.
Is Valhi Efficiently Re-investing Its Profits?
Valhi has a low three-year median payout ratio of 22%, meaning that the company retains the remaining 78% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Additionally, Valhi has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.
Summary
On the whole, we do feel that Valhi 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for Valhi by visiting our risks dashboard for free on our platform here.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
