PETRONAS Chemicals Group Berhad's (KLSE:PCHEM) stock up by 3.4% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on PETRONAS Chemicals Group Berhad's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 PETRONAS Chemicals Group Berhad is:
17% = RM5.7b ÷ RM34b (Based on the trailing twelve months to September 2021).
The 'return' is the income the business earned over the last year. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.17 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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 PETRONAS Chemicals Group Berhad's Earnings Growth And 17% ROE
At first glance, PETRONAS Chemicals Group Berhad seems to have a decent ROE. On comparing with the average industry ROE of 8.2% the company's ROE looks pretty remarkable. For this reason, PETRONAS Chemicals Group Berhad's five year net income decline of 3.9% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
That being said, we compared PETRONAS Chemicals Group Berhad's 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 2.8% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. What is PCHEM worth today? The intrinsic value infographic in our free research report helps visualize whether PCHEM is currently mispriced by the market.
Is PETRONAS Chemicals Group Berhad Efficiently Re-investing Its Profits?
PETRONAS Chemicals Group Berhad has a high three-year median payout ratio of 57% (that is, it is retaining 43% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. 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. You can see the 2 risks we have identified for PETRONAS Chemicals Group Berhad by visiting our risks dashboard for free on our platform here.
In addition, PETRONAS Chemicals Group Berhad 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 56%. Accordingly, forecasts suggest that PETRONAS Chemicals Group Berhad's future ROE will be 15% which is again, similar to the current ROE.
In total, it does look like PETRONAS Chemicals Group Berhad has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. In addition, on studying the latest analyst forecasts, we found that the company's earnings are expected to continue to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.