Wärtsilä Oyj Abp's (HEL:WRT1V) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

By
Simply Wall St
Published
July 08, 2021
HLSE:WRT1V
Source: Shutterstock

Wärtsilä Oyj Abp (HEL:WRT1V) has had a great run on the share market with its stock up by a significant 43% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Wärtsilä Oyj Abp'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Wärtsilä Oyj Abp

How Is ROE Calculated?

Return on equity 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 Wärtsilä Oyj Abp is:

5.9% = €127m ÷ €2.1b (Based on the trailing twelve months to March 2021).

The 'return' is the income the business earned over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.06 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.

Wärtsilä Oyj Abp's Earnings Growth And 5.9% ROE

At first glance, Wärtsilä Oyj Abp's ROE doesn't look very promising. Next, when compared to the average industry ROE of 11%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 16% seen by Wärtsilä Oyj Abp was probably the 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 example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 3.7% in the same period, we found that Wärtsilä Oyj Abp's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

past-earnings-growth
HLSE:WRT1V Past Earnings Growth July 8th 2021

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. If you're wondering about Wärtsilä Oyj Abp's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Wärtsilä Oyj Abp Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 88% (implying that 12% of the profits are retained), most of Wärtsilä Oyj Abp's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 2 risks we have identified for Wärtsilä Oyj Abp.

Additionally, Wärtsilä Oyj Abp has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 64% over the next three years. The fact that the company's ROE is expected to rise to 14% over the same period is explained by the drop in the payout ratio.

Summary

Overall, we would be extremely cautious before making any decision on Wärtsilä Oyj Abp. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. 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 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. 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.
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