Croda International Plc's (LON:CRDA) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Croda International (LON:CRDA) has had a rough month with its share price down 6.3%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Croda International's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Croda International

How To Calculate Return On Equity?

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 Croda International is:

27% = UK£653m ÷ UK£2.4b (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.27 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. 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.

A Side By Side comparison of Croda International's Earnings Growth And 27% ROE

Firstly, we acknowledge that Croda International has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 9.9% also doesn't go unnoticed by us. So, the substantial 24% net income growth seen by Croda International over the past five years isn't overly surprising.

Given that the industry shrunk its earnings at a rate of 1.0% in the same period, the net income growth of the company is quite impressive.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Croda International's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Croda International Efficiently Re-investing Its Profits?

Croda International has a significant three-year median payout ratio of 52%, meaning the company only retains 48% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Besides, Croda International has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 44%. Regardless, Croda International's ROE is speculated to decline to 14% despite there being no anticipated change in its payout ratio.

Summary

Overall, we are quite pleased with Croda International's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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