PETRONAS Chemicals Group Berhad's (KLSE:PCHEM) stock is up by 3.1% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study PETRONAS Chemicals Group Berhad's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for PETRONAS Chemicals Group Berhad

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for PETRONAS Chemicals Group Berhad is:

21% = RM7.9b ÷ RM38b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.21 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of PETRONAS Chemicals Group Berhad's Earnings Growth And 21% ROE

To start with, PETRONAS Chemicals Group Berhad's ROE looks acceptable. On comparing with the average industry ROE of 8.5% the company's ROE looks pretty remarkable. This certainly adds some context to PETRONAS Chemicals Group Berhad's decent 8.6% net income growth seen over the past five years.

We then compared PETRONAS Chemicals Group Berhad's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 18% in the same period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is PCHEM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is PETRONAS Chemicals Group Berhad Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 56% (or a retention ratio of 44%) for PETRONAS Chemicals Group Berhad suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, PETRONAS Chemicals Group Berhad is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. 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 51%. However, PETRONAS Chemicals Group Berhad's future ROE is expected to decline to 16% despite there being not much change anticipated in the company's payout ratio.

Conclusion

Overall, we feel that PETRONAS Chemicals Group Berhad certainly does have some positive factors to consider. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink 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.

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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