Victrex plc's (LON:VCT) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?
Victrex (LON:VCT) has had a rough three months with its share price down 8.2%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Victrex's ROE.
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.
View our latest analysis for Victrex
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 Victrex is:
20% = UK£92m ÷ UK£462m (Based on the trailing twelve months to September 2019).
The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.20 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Victrex's Earnings Growth And 20% ROE
At first glance, Victrex seems to have a decent ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This certainly adds some context to Victrex's decent 6.2% net income growth seen over the past five years.
We then compared Victrex'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.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is VCT worth today? The intrinsic value infographic in our free research report helps visualize whether VCT is currently mispriced by the market.
Is Victrex Using Its Retained Earnings Effectively?
Victrex has a healthy combination of a moderate three-year median payout ratio of 48% (or a retention ratio of 52%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Additionally, Victrex 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 76% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
Conclusion
On the whole, we feel that Victrex's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
