Could The Market Be Wrong About Vesuvius plc (LON:VSVS) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Vesuvius' (LON:VSVS) recent performance, when its stock has declined 5.9% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Vesuvius' ROE.

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 Vesuvius

How Is ROE Calculated?

The formula for ROE is:

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

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

9.9% = UK£131m ÷ UK£1.3b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.10 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Vesuvius' Earnings Growth And 9.9% ROE

To begin with, Vesuvius seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 14% does temper our expectations. Vesuvius was still able to see a decent net income growth of 12% over the past five years. So, there might be other aspects that are positively influencing earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.

As a next step, we compared Vesuvius' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 9.8%.

Earnings growth is an important metric to consider when valuing a stock. 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 Vesuvius''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Vesuvius Using Its Retained Earnings Effectively?

Vesuvius has a healthy combination of a moderate three-year median payout ratio of 48% (or a retention ratio of 52%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Vesuvius is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 44%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 11%.

Summary

Overall, we are quite pleased with Vesuvius' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.

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