Are Westlake Chemical Corporation's (NYSE:WLK) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?
It is hard to get excited after looking at Westlake Chemical's (NYSE:WLK) recent performance, when its stock has declined 3.8% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Westlake Chemical's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Westlake Chemical
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 Westlake Chemical is:
13% = US$981m ÷ US$7.3b (Based on the trailing twelve months to June 2021).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.13 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Westlake Chemical's Earnings Growth And 13% ROE
To start with, Westlake Chemical's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. As you might expect, the 5.4% net income decline reported by Westlake Chemical is a bit of a surprise. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
So, as a next step, we compared Westlake Chemical's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 3.3% in the same period.
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. 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 WLK? You can find out in our latest intrinsic value infographic research report.
Is Westlake Chemical Efficiently Re-investing Its Profits?
Looking at its three-year median payout ratio of 27% (or a retention ratio of 73%) which is pretty normal, Westlake Chemical's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In addition, Westlake Chemical 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 14% over the next three years. As a result, the expected drop in Westlake Chemical's payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.
Summary
Overall, we feel that Westlake Chemical certainly does have some positive factors to consider. 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. Additionally, the latest industry analyst forecasts show that analysts expect the company's earnings to continue to shrink 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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