NewMarket Corporation's (NYSE:NEU) Stock Is Going Strong: Have Financials A Role To Play?

NewMarket (NYSE:NEU) has had a great run on the share market with its stock up by a significant 21% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to NewMarket's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for NewMarket

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 NewMarket is:

35% = US$254m ÷ US$724m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.35 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

NewMarket's Earnings Growth And 35% ROE

To begin with, NewMarket has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 10% also doesn't go unnoticed by us. Despite this, NewMarket's five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared NewMarket's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 7.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if NewMarket is trading on a high P/E or a low P/E, relative to its industry.

Is NewMarket Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 34% (or a retention ratio of 66%), NewMarket hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, NewMarket 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.

Conclusion

On the whole, we do feel that NewMarket has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on NewMarket and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

If you decide to trade NewMarket, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.