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Element Solutions Inc's (NYSE:ESI) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Simply Wall St ·  {{timeTz}}

With its stock down 16% over the past month, it is easy to disregard Element Solutions (NYSE:ESI). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Element Solutions' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Element Solutions

How Is ROE Calculated?

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 Element Solutions is:

6.7% = US$162m ÷ US$2.4b (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.07.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Element Solutions' Earnings Growth And 6.7% ROE

On the face of it, Element Solutions' ROE is not much to talk about. Next, when compared to the average industry ROE of 16%, the company's ROE leaves us feeling even less enthusiastic. In spite of this, Element Solutions was able to grow its net income considerably, at a rate of 68% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Element Solutions' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 9.3%.

past-earnings-growthNYSE:ESI Past Earnings Growth September 25th 2022

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Element Solutions is trading on a high P/E or a low P/E, relative to its industry.

Is Element Solutions Efficiently Re- investing Its Profits?

Element Solutions' ' three-year median payout ratio is on the lower side at 24% implying that it is retaining a higher percentage (76%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

While Element Solutions has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 19% over the next three years. As a result, the expected drop in Element Solutions' payout ratio explains the anticipated rise in the company's future ROE to 17%, over the same period.

Summary

In total, it does look like Element Solutions has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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