Yahoo Finance Should Weakness in Victrex plc's (LON:VCT) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?
It is hard to get excited after looking at Victrex's (LON:VCT) recent performance, when its stock has declined 12% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Victrex'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Victrex
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 Victrex is:
15% = UK£70m ÷ UK£471m (Based on the trailing twelve months to March 2022).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.15.
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.
Victrex's Earnings Growth And 15% ROE
To begin with, Victrex seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. Needless to say, we are quite surprised to see that Victrex's net income shrunk at a rate of 11% over the past five years. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
That being said, we compared Victrex's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 5.8% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. What is VCT worth today? The intrinsic value infographic in our free research report helps visualize whether VCT is currently mispriced by the market.
Is Victrex Making Efficient Use Of Its Profits?
Victrex has a high three-year median payout ratio of 71% (that is, it is retaining 29% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.
Moreover, Victrex has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 57%. However, Victrex's ROE is predicted to rise to 19% despite there being no anticipated change in its payout ratio.
Summary
On the whole, we do feel that Victrex has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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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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