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Weak Financial Prospects Seem To Be Dragging Down Johnson Matthey Plc (LON:JMAT) Stock

With its stock down 10% over the past three months, it is easy to disregard Johnson Matthey (LON:JMAT). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to Johnson Matthey'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Johnson Matthey

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

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So, based on the above formula, the ROE for Johnson Matthey is:

4.8% = UK£116m ÷ UK£2.4b (Based on the trailing twelve months to March 2022).

The 'return' is the amount earned after tax 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 £0.05 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. 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. 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.

Johnson Matthey's Earnings Growth And 4.8% ROE

At first glance, Johnson Matthey's 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. For this reason, Johnson Matthey's five year net income decline of 20% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

So, as a next step, we compared Johnson Matthey's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 5.8% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is JMAT worth today? The intrinsic value infographic in our free research report helps visualize whether JMAT is currently mispriced by the market.

Is Johnson Matthey Making Efficient Use Of Its Profits?

Johnson Matthey's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 63% (or a retention ratio of 37%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 3 risks we have identified for Johnson Matthey by visiting our risks dashboard for free on our platform here.

In addition, Johnson Matthey has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 39% over the next three years. As a result, the expected drop in Johnson Matthey's payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.

Conclusion

Overall, we would be extremely cautious before making any decision on Johnson Matthey. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.

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

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.

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