DSM-Firmenich AG's (AMS:DSFIR) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

DSM-Firmenich (AMS:DSFIR) has had a great run on the share market with its stock up by a significant 13% over the last week. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study DSM-Firmenich's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 DSM-Firmenich

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for DSM-Firmenich is:

1.2% = €280m ÷ €23b (Based on the trailing twelve months to December 2024).

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 €0.01 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 DSM-Firmenich's Earnings Growth And 1.2% ROE

As you can see, DSM-Firmenich's ROE looks pretty weak. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 41% seen by DSM-Firmenich was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 6.0% over the last few years, we found that DSM-Firmenich's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

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). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for DSFIR? You can find out in our latest intrinsic value infographic research report.

Is DSM-Firmenich Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 53% (implying that 47% of the profits are retained), most of DSM-Firmenich's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Additionally, DSM-Firmenich started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline. 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 52%. However, DSM-Firmenich's ROE is predicted to rise to 5.9% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning DSM-Firmenich. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.