Sociedad Química y Minera de Chile (NYSE:SQM) has had a great run on the share market with its stock up by a significant 51% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Sociedad Química y Minera de Chile's ROE.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Sociedad Química y Minera de Chile is:
18% = US$592m ÷ US$3.2b (Based on the trailing twelve months to December 2021).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.18.
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.
Sociedad Química y Minera de Chile's Earnings Growth And 18% ROE
To begin with, Sociedad Química y Minera de Chile seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 16%. For this reason, Sociedad Química y Minera de Chile's five year net income decline of 6.5% raises the question as to why the decent ROE didn't translate into growth. 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. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared Sociedad Química y Minera de Chile'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 7.3% in the same period.
NYSE:SQM Past Earnings Growth May 6th 2022
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Sociedad Química y Minera de Chile's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Sociedad Química y Minera de Chile Using Its Retained Earnings Effectively?
Sociedad Química y Minera de Chile has a high three-year median payout ratio of 89% (that is, it is retaining 11% 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 a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 3 risks we have identified for Sociedad Química y Minera de Chile visit our risks dashboard for free.
Moreover, Sociedad Química y Minera de Chile 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 68% over the next three years. As a result, the expected drop in Sociedad Química y Minera de Chile's payout ratio explains the anticipated rise in the company's future ROE to 69%, over the same period.
Conclusion
On the whole, we do feel that Sociedad Química y Minera de Chile has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. 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.
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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.
