Should Weakness in EMS-CHEMIE HOLDING AG's (VTX:EMSN) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 9.7% over the past month, it is easy to disregard EMS-CHEMIE HOLDING (VTX:EMSN). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to EMS-CHEMIE HOLDING's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for EMS-CHEMIE HOLDING

How To 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 EMS-CHEMIE HOLDING is:

29% = CHF553m ÷ CHF1.9b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CHF1 of shareholders' capital it has, the company made CHF0.29 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. 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 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 EMS-CHEMIE HOLDING's Earnings Growth And 29% ROE

Firstly, we acknowledge that EMS-CHEMIE HOLDING has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 14% also doesn't go unnoticed by us. Despite this, EMS-CHEMIE HOLDING's five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared EMS-CHEMIE HOLDING's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 4.6% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if EMS-CHEMIE HOLDING is trading on a high P/E or a low P/E, relative to its industry.

Is EMS-CHEMIE HOLDING Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 70% (meaning, the company retains only 30% of profits) for EMS-CHEMIE HOLDING suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Moreover, EMS-CHEMIE HOLDING 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 81% of its profits over the next three years. As a result, EMS-CHEMIE HOLDING's ROE is not expected to change by much either, which we inferred from the analyst estimate of 33% for future ROE.

Summary

In total, it does look like EMS-CHEMIE HOLDING has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.