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Clariant (VTX:CLN) has had a rough month with its share price down 8.2%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Clariant's ROE.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Clariant
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Clariant is:
13% = CHF376m ÷ CHF2.9b (Based on the trailing twelve months to June 2022).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CHF1 worth of equity, the company was able to earn CHF0.13 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. 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.
Clariant's Earnings Growth And 13% ROE
To start with, Clariant's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 16%. Despite this, Clariant's five year net income growth was quite flat over the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
As a next step, we compared Clariant's net income growth with the industry and discovered that the industry saw an average growth of 2.8% in the same period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for CLN? You can find out in our latest intrinsic value infographic research report.