Declining Stock and Solid Fundamentals: Is The Market Wrong About Sika AG (VTX:SIKA)?

Sika (VTX:SIKA) has had a rough week with its share price down 5.1%. 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 Sika'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Sika

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 Sika is:

19% = CHF1.2b ÷ CHF6.4b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every CHF1 worth of shareholders' equity, the company generated CHF0.19 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.

Sika's Earnings Growth And 19% ROE

To begin with, Sika seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 19%. Consequently, this likely laid the ground for the decent growth of 10% seen over the past five years by Sika.

Next, on comparing with the industry net income growth, we found that Sika's growth is quite high when compared to the industry average growth of 6.8% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is SIKA fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sika Efficiently Re-investing Its Profits?

Sika has a three-year median payout ratio of 43%, which implies that it retains the remaining 57% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Sika is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 43%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 20%.

Conclusion

On the whole, we feel that Sika's performance has been quite good. 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. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.