Dow (NYSE:DOW) stock is up 8.6% over the past three months. We wonder if and what role the company’s financials play in this price change, because a company’s long-term fundamentals generally dictate market outcomes. In this article, we decided to focus on the Dow’s ROE.
ROE or return on equity is a useful tool for assessing how effectively a company can generate returns on the investment it has received from its shareholders. In simpler terms, it measures a company’s profitability relative to shareholders’ equity.
See our latest analysis for Dow
How is ROE calculated?
Return on equity can be calculated using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the formula above, the ROE of the Dow is:
3.5% = US$660 million ÷ US$19 billion (based on the trailing twelve months to December 2023).
The “yield” is the profit over the last twelve months. This means that for every dollar of shareholders’ equity, the company generated $0.03 in profit.
Why is ROE important for profit growth?
So far, we have learned that ROE measures how efficiently a company generates its profits. We now need to assess how much profit the company reinvests or “retains” for future growth, which then gives us an idea of the company’s growth potential. Generally speaking, all else being equal, companies with high return on equity and profit retention have a higher growth rate than companies that do not share these attributes.
A Side-by-Side Comparison of Dow Earnings Growth and ROE of 3.5%
As you can see, the Dow’s ROE looks pretty low. Even compared to the industry average of 13%, the ROE figure is quite disappointing. Despite this, Dow has been able to grow its net income significantly, at a rate of 23% over the past five years. So there could be other reasons behind this growth. Such as – high profit retention or effective management in place.
We then compared Dow’s net profit growth with that of the industry and we are happy to see that the company’s growth figure is higher than that of the industry which has a growth rate of 14% during the same period of 5 years.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to determine whether expected earnings growth or decline, whatever the case may be, is taken into account. This will help him determine whether the stock’s future looks promising or worrisome. Is DOW correctly valued? This infographic on intrinsic business value has everything you need to know.
Is Dow reinvesting its profits effectively?
Dow has a three-year median payout ratio of 51%, meaning the company only retains 49% of its earnings. This implies that the company managed to achieve high earnings growth even though most of its profits were returned to shareholders.
Additionally, Dow is committed to continuing to share its profits with its shareholders, which we infer from its five-year long history of paying dividends. Our latest analyst data shows that the company’s future payout ratio over the next three years is expected to be around 56%. However, Dow’s ROE is expected to reach 18%, although no changes are expected in its payout ratio.
Conclusion
Overall, we think Dow certainly has some positive factors to consider. That is to say, quite impressive profit growth. However, low profit retention means that the company’s earnings growth could have been higher if it had reinvested more of its profits. That said, the latest forecasts from industry analysts reveal that the company’s earnings are expected to accelerate. To learn more about the latest analyst forecasts for the company, check out this visualization of analyst forecasts for the company.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to constitute financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your objectives or your financial situation. Our goal is to provide you with targeted, long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
