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Sociedad Química y Minera de Chile (NYSE:SQM) has had a rough week with its share price down 5.6%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Sociedad Química y Minera de Chile'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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 Sociedad Química y Minera de Chile is:
7.8% = US$168m ÷ US$2.2b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Sociedad Química y Minera de Chile's Earnings Growth And 7.8% ROE
At first glance, Sociedad Química y Minera de Chile's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10% either. Hence, the flat earnings seen by Sociedad Química y Minera de Chile over the past five years could probably be the result of it having a lower ROE.
As a next step, we compared Sociedad Química y Minera de Chile's net income growth with the industry and discovered that the industry saw an average growth of 5.4% 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. 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 Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 100% (implying that the company keeps only 0.001% of its income) of its business to reinvest into its business), most of Sociedad Química y Minera de Chile's profits are being paid to shareholders, which explains the absence of growth in earnings.
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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 70% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 21%, over the same period.
On the whole, Sociedad Química y Minera de Chile's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.
This article by Simply Wall St is general in nature. 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.
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