With its stock down 6.2% over the past week, it is easy to disregard Element Solutions (NYSE:ESI). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Element Solutions' ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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:

5.0% = US$116m ÷ US$2.3b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Element Solutions' Earnings Growth And 5.0% ROE

At first glance, Element Solutions' ROE doesn't look very promising. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. Despite this, surprisingly, Element Solutions saw an exceptional 31% net income growth over the past five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Element Solutions' growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is ESI fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Element Solutions Using Its Retained Earnings Effectively?

Element Solutions' three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Element Solutions is reinvesting its earnings efficiently.

Moreover, Element Solutions is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 20% over the next three years. The fact that the company's ROE is expected to rise to 15% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, it does look like Element Solutions has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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.

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.