Are Poor Financial Prospects Dragging Down Evonik Industries AG (ETR:EVK Stock?

Evonik Industries (ETR:EVK) has had a rough month with its share price down 14%. 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. Specifically, we decided to study Evonik Industries' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Evonik Industries

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 Evonik Industries is:

2.7% = €245m ÷ €9.1b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.03.

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Evonik Industries' Earnings Growth And 2.7% ROE

It is quite clear that Evonik Industries' ROE is rather low. Even compared to the average industry ROE of 8.5%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 35% seen by Evonik Industries was possibly a result of it having a lower ROE. 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.

That being said, we compared Evonik Industries' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 9.6% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Evonik Industries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Evonik Industries Efficiently Re-investing Its Profits?

Evonik Industries' 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 59% (or a retention ratio of 41%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 2 risks we have identified for Evonik Industries by visiting our risks dashboard for free on our platform here.

Moreover, Evonik Industries 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 63%. Still, forecasts suggest that Evonik Industries' future ROE will rise to 10% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we would be extremely cautious before making any decision on Evonik Industries. 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. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.