It is hard to get excited after looking at Koninklijke DSM's (AMS:DSM) recent performance, when its stock has declined 3.0% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Koninklijke DSM's ROE.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Koninklijke DSM
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 Koninklijke DSM is:
11% = €1.1b ÷ €9.8b (Based on the trailing twelve months to June 2022).
The 'return' is the amount earned after tax over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.11 in profit.
What Is The Relationship Between ROE And 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 Koninklijke DSM's Earnings Growth And 11% ROE
To start with, Koninklijke DSM's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. However, while Koninklijke DSM has a pretty respectable ROE, its five year net income decline rate was 18% . Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.
That being said, we compared Koninklijke DSM's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Koninklijke DSM's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.