Most readers would already know that Westag’s (FRA:WUG) stock increased by 3.1% over the past week. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Particularly, we will be paying attention to Westag’s ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Westag
How Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Westag is:
3.4% = €2.7m ÷ €79m (Based on the trailing twelve months to December 2023).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each €1 of shareholders’ capital it has, the company made €0.03 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. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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 Westag’s Earnings Growth And 3.4% ROE
When you first look at it, Westag’s ROE doesn’t look that attractive. We then compared the company’s ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 14%. Given the circumstances, the significant decline in net income by 39% seen by Westag over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as – low earnings retention or poor allocation of capital.
That being said, we compared Westag’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 15% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Westag is trading on a high P/E or a low P/E, relative to its industry.
Is Westag Using Its Retained Earnings Effectively?
Westag has a high three-year median payout ratio of 72% (that is, it is retaining 28% 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. The business is only left with a small pool of capital to reinvest – A vicious cycle that doesn’t benefit the company in the long-run. Our risks dashboard should have the 2 risks we have identified for Westag.
Additionally, Westag has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth.
Summary
In total, we would have a hard think before deciding on any investment action concerning Westag. Because the company is not reinvesting much into the business, and given the low ROE, it’s not surprising to see the lack or absence of growth in its earnings. So far, we’ve only made a quick discussion around the company’s earnings growth. So it may be worth checking this free detailed graph of Westag’s past earnings, as well as revenue and cash flows to get a deeper insight into the company’s performance.
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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.