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It is hard to get excited after looking at DuPont de Nemours' (NYSE:DD) recent performance, when its stock has declined 20% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study DuPont de Nemours' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 DuPont de Nemours is:
6.2% = US$1.7b ÷ US$27b (Based on the trailing twelve months to March 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.06 in profit.
Why Is ROE Important For 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 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.
A Side By Side comparison of DuPont de Nemours' Earnings Growth And 6.2% ROE
On the face of it, DuPont de Nemours' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 17% either. Given the circumstances, the significant decline in net income by 26% seen by DuPont de Nemours over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared DuPont de Nemours' 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 8.0% in the same period.
Earnings growth is a huge factor in stock valuation. 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. Is DuPont de Nemours fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is DuPont de Nemours Efficiently Re-investing Its Profits?
In spite of a normal LTM (or last twelve month) payout ratio of 40% (that is, a retention ratio of 60%), the fact that DuPont de Nemours' earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, DuPont de Nemours 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 34%. However, DuPont de Nemours' ROE is predicted to rise to 8.0% despite there being no anticipated change in its payout ratio.
In total, we're a bit ambivalent about DuPont de Nemours' performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.