Declining Stock and Solid Fundamentals: Is The Market Wrong About Norsk Hydro ASA (OB:NHY)?

It is hard to get excited after looking at Norsk Hydro's (OB:NHY) recent performance, when its stock has declined 15% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Norsk Hydro'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Norsk Hydro

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 Norsk Hydro is:

17% = kr19b ÷ kr114b (Based on the trailing twelve months to March 2023).

The 'return' is the yearly profit. So, this means that for every NOK1 of its shareholder's investments, the company generates a profit of NOK0.17.

What Is The Relationship Between ROE And 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. 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.

Norsk Hydro's Earnings Growth And 17% ROE

To begin with, Norsk Hydro seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 14%. Consequently, this likely laid the ground for the impressive net income growth of 43% seen over the past five years by Norsk Hydro. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Norsk Hydro's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 22% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is NHY worth today? The intrinsic value infographic in our free research report helps visualize whether NHY is currently mispriced by the market.

Is Norsk Hydro Using Its Retained Earnings Effectively?

The three-year median payout ratio for Norsk Hydro is 35%, which is moderately low. The company is retaining the remaining 65%. By the looks of it, the dividend is well covered and Norsk Hydro is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Norsk Hydro has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 68% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we are quite pleased with Norsk Hydro's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.