West Pharmaceutical Services, Inc.'s (NYSE:WST) Stock Been Rising: Are Strong Financials Guiding The Market?

West Pharmaceutical Services' (NYSE:WST) stock up by 6.9% over the past three months. Since the market usually pay for a company’s long-term financial health, we decided to study the company’s fundamentals to see if they could be influencing the market. In this article, we decided to focus on West Pharmaceutical Services' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for West Pharmaceutical Services

How Do You 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$500m ÷ US$2.8b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.18 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. 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.

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. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to West Pharmaceutical Services' decent 14% net income growth seen over the past five years.

We then performed a comparison between West Pharmaceutical Services' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 12% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is West Pharmaceutical Services fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is West Pharmaceutical Services Efficiently Re-investing Its Profits?

In West Pharmaceutical Services' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 9.6% (or a retention ratio of 90%), which suggests that the company is investing most of its profits to grow its business.

Additionally, West Pharmaceutical Services has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 20% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, we are pretty happy with West Pharmaceutical Services' 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. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.