Neste Oyj (HEL:NESTE) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

With its stock down 17% over the past month, it is easy to disregard Neste Oyj (HEL:NESTE). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Neste Oyj'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Neste Oyj

How Is ROE Calculated?

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 Neste Oyj is:

13% = €957m ÷ €7.5b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Neste Oyj's Earnings Growth And 13% ROE

At first glance, Neste Oyj seems to have a decent ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. Neste Oyj's decent returns aren't reflected in Neste Oyj'smediocre five year net income growth average of 2.6%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared Neste Oyj's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 31% in the same 5-year period, which is a bit concerning.

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. 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 Neste Oyj is trading on a high P/E or a low P/E, relative to its industry.

Is Neste Oyj Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 51% (that is, the company retains only 49% of its income) over the past three years for Neste Oyj suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Neste Oyj 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 57% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 13%.

Conclusion

In total, it does look like Neste Oyj has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.