Is BASF SE's (ETR:BAS) Recent Performance Underpinned By Weak Financials?

It is hard to get excited after looking at BASF's (ETR:BAS) recent performance, when its stock has declined 20% over the past month. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to BASF'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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How To Calculate Return On Equity?

ROE can be calculated by using the formula:

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

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

3.9% = €1.5b ÷ €37b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.04 in profit.

Check out our latest analysis for BASF

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. 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.

A Side By Side comparison of BASF's Earnings Growth And 3.9% ROE

When you first look at it, BASF's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.0% either. Given the circumstances, the significant decline in net income by 16% seen by BASF over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared BASF's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.3% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about BASF's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is BASF Efficiently Re-investing Its Profits?

BASF's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 56% (or a retention ratio of 44%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 3 risks we have identified for BASF visit our risks dashboard for free.

In addition, BASF 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 over the next three years is expected to be approximately 54%. Still, forecasts suggest that BASF's future ROE will rise to 11% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we would be extremely cautious before making any decision on BASF. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings 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.

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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.