Solvay's (EBR:SOLB) stock is up by 5.2% over the past three months. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Particularly, we will be paying attention to Solvay's ROE today.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Solvay is:
8.1% = €685m ÷ €8.5b (Based on the trailing twelve months to September 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Solvay's Earnings Growth And 8.1% ROE
When you first look at it, Solvay's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 9.6%, we may spare it some thought. But then again, Solvay's five year net income shrunk at a rate of 40%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 9.2% in the same period, we still found Solvay's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is SOLB worth today? The intrinsic value infographic in our free research report helps visualize whether SOLB is currently mispriced by the market.
Is Solvay Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 49% (where it is retaining 51% of its profits), Solvay has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Solvay 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 40% of its profits over the next three years. Still, forecasts suggest that Solvay's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.
Overall, we have mixed feelings about Solvay. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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.
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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.