Are Koninklijke DSM N.V.'s (AMS:DSM) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

Koninklijke DSM (AMS:DSM) has had a rough month with its share price down 5.2%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Koninklijke DSM's ROE in this article.

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. 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 Koninklijke DSM

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 Koninklijke DSM is:

6.1% = €457m ÷ €7.5b (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.06.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of Koninklijke DSM's Earnings Growth And 6.1% ROE

On the face of it, Koninklijke DSM's ROE is not much to talk about. However, its ROE is similar to the industry average of 7.5%, so we won't completely dismiss the company. We can see that Koninklijke DSM has grown at a five year net income growth average rate of 4.0%, which is a bit on the lower side. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.

Next, on comparing Koninklijke DSM's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 4.0% 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Koninklijke DSM's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Koninklijke DSM Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 49% (implying that the company retains the remaining 51% of its income), Koninklijke DSM's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Koninklijke DSM 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 46% of its profits over the next three years. However, Koninklijke DSM's ROE is predicted to rise to 12% despite there being no anticipated change in its payout ratio.

Summary

Overall, we feel that Koninklijke DSM certainly does have some positive factors to consider. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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