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Victrex (LON:VCT) has had a rough month with its share price down 10%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Victrex's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Victrex is:
11% = UK£54m ÷ UK£484m (Based on the trailing twelve months to March 2021).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.11 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Victrex's Earnings Growth And 11% ROE
To begin with, Victrex seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 12%. As you might expect, the 5.2% net income decline reported by Victrex is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared Victrex's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.6% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for VCT? You can find out in our latest intrinsic value infographic research report.
Is Victrex Making Efficient Use Of Its Profits?
Victrex has a high three-year median payout ratio of 50% (that is, it is retaining 50% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely.
In addition, Victrex has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 61% over the next three years. Regardless, the future ROE for Victrex is speculated to rise to 18% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
In total, it does look like Victrex has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
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