Quaker Chemical (NYSE:KWR) has had a rough week with its share price down 13%. 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 Quaker Chemical’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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
See our latest analysis for Quaker Chemical
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Quaker Chemical is:
3.0% = US$40m ÷ US$1.3b (Based on the trailing twelve months to December 2020).
The ‘return’ is the yearly profit. That means that for every $1 worth of shareholders’ equity, the company generated $0.03 in profit.
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. 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.
Quaker Chemical’s Earnings Growth And 3.0% ROE
It is quite clear that Quaker Chemical’s ROE is rather low. Even compared to the average industry ROE of 10%, the company’s ROE is quite dismal. Given the circumstances, the significant decline in net income by 23% seen by Quaker Chemical over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as – low earnings retention or poor allocation of capital.
However, when we compared Quaker Chemical’s growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 5.7% in the same period. This is quite worrisome.
Earnings growth is an important metric to consider when valuing a stock. 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. 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 Quaker Chemical is trading on a high P/E or a low P/E, relative to its industry.
Is Quaker Chemical Using Its Retained Earnings Effectively?
Quaker Chemical has a high three-year median payout ratio of 57% (that is, it is retaining 43% 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 very little left to reinvest into the business, growth in earnings is far from likely. To know the 2 risks we have identified for Quaker Chemical visit our risks dashboard for free.
Moreover, Quaker Chemical 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. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 17% over the next three years. As a result, the expected drop in Quaker Chemical’s payout ratio explains the anticipated rise in the company’s future ROE to 20%, over the same period.
In total, we would have a hard think before deciding on any investment action concerning Quaker Chemical. Because the company is not reinvesting much into the business, and given the low ROE, it’s not surprising to see the lack or absence of growth in its earnings. 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. 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.
This article by Simply Wall St is general in nature. 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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