Solvay SA's (EBR:SOLB) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 6.6% over the past month, it is easy to disregard Solvay (EBR:SOLB). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Solvay's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Solvay

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Solvay is:

17% = €1.8b ÷ €11b (Based on the trailing twelve months to March 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.17 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Solvay's Earnings Growth And 17% ROE

At first glance, Solvay seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 16%. This probably goes some way in explaining Solvay's significant 23% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing Solvay's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 20% 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. This then helps them determine if the stock is placed for a bright or bleak future. 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?

Solvay's three-year median payout ratio to shareholders is 22%, which is quite low. This implies that the company is retaining 78% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Additionally, Solvay 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 34% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 12% over the same period.

Summary

Overall, we are quite pleased with Solvay's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.