Stock Analysis

West Pharmaceutical Services, Inc.'s (NYSE:WST) Stock Has Fared Decently: Is the Market Following Strong Financials?

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NYSE:WST
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West Pharmaceutical Services' (NYSE:WST) stock is up by 6.9% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on West Pharmaceutical Services' ROE.

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 West Pharmaceutical Services

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for West Pharmaceutical Services is:

18% = US$312m ÷ US$1.7b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 West Pharmaceutical Services' Earnings Growth And 18% ROE

To begin with, West Pharmaceutical Services seems to have a respectable ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This certainly adds some context to West Pharmaceutical Services' exceptional 21% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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.

Next, on comparing with the industry net income growth, we found that West Pharmaceutical Services' growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

past-earnings-growth
NYSE:WST Past Earnings Growth January 27th 2021

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. Is West Pharmaceutical Services fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is West Pharmaceutical Services Using Its Retained Earnings Effectively?

West Pharmaceutical Services' three-year median payout ratio to shareholders is 20%, which is quite low. This implies that the company is retaining 80% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, West Pharmaceutical Services 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 drop to 13% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

Overall, we are quite pleased with West Pharmaceutical Services' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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