Vesuvius (LON:VSVS) has had a rough month with its share price down 4.5%. We, however decided to study the company’s financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it’s worth paying close attention. In this article, we decided to focus on Vesuvius’ ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
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 Vesuvius is:
6.0% = UK£67m ÷ UK£1.1b (Based on the trailing twelve months to June 2021).
The ‘return’ is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders’ equity, the company generated £0.06 in profit.
Why Is ROE Important For Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Vesuvius’ Earnings Growth And 6.0% ROE
At first glance, Vesuvius’ ROE doesn’t look very promising. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 11% either. As a result, Vesuvius reported a very low income growth of 3.2% over the past five years.
We then compared Vesuvius’ net income growth with the industry and found that the company’s growth figure is lower than the average industry growth rate of 6.4% in the same period, which is a bit concerning.
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. Doing so will help them establish if the stock’s future looks promising or ominous. What is VSVS worth today? The intrinsic value infographic in our free research report helps visualize whether VSVS is currently mispriced by the market.
Is Vesuvius Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 43% (or a retention ratio of 57% over the past three years, Vesuvius has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company’s business may be deteriorating.
Additionally, Vesuvius has paid dividends over a period of eight years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts’ estimates, we found that the company’s future payout ratio over the next three years is expected to hold steady at 44%. Still, forecasts suggest that Vesuvius’ future ROE will rise to 11% even though the the company’s payout ratio is not expected to change by much.
In total, we’re a bit ambivalent about Vesuvius’ performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. 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.
If you decide to trade Vesuvius, 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. 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.
*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.