Norsk Hydro (OB: NHY) has had a strong run in the equity market with a significant 12% increase in its shares over the past month. Since stock prices are generally aligned with a company’s long-term financial performance, we decided to take a closer look at its financial metrics to see if they had a role to play in the recent price movement. . In this article, we have decided to focus on the ROE of Norsk Hydro.
Return on equity or ROE is an important factor for a shareholder to consider, as it tells them how efficiently their capital is being reinvested. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.
Check out our latest review for Norsk Hydro
How to calculate return on equity?
the formula for ROE is:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, Norsk Hydro’s ROE is:
13% = kr10b kr81b (based on the last twelve months up to September 2021).
The “return” is the profit of the last twelve months. This means that for every NOK1 value of equity, the company generated NOK0.13 in profit.
What is the relationship between ROE and profit growth?
So far, we’ve learned that ROE measures how efficiently a business generates profits. We now need to assess the profits that the business is reinvesting or âwithholdingâ for future growth, which then gives us an idea of ââthe growth potential of the business. Generally speaking, all other things being equal, companies with high return on equity and high profit retention have a higher growth rate than companies that do not share these attributes.
Norsk Hydro profit growth and 13% ROE
For starters, Norsk Hydro’s ROE seems acceptable. Yet the fact that the company’s ROE is 16% below the industry average tempers our expectations. Needless to say, the 20% net income shrinkage rate seen by Norsk Hydro over the past five years is a huge drag. Remember, the business has a high ROE to start with, just lower than the industry average. Therefore, lower profits could be the result of other factors. For example, the company pays out a large portion of its profits as dividends or faces competitive pressures.
In the next step, we compared the performance of Norsk Hydro with the industry and found that the performance of Norsk Hydro is depressing even when compared to the industry, which cut its profits by 0.4% over the course of the same period, which is slower than the business.
The basis for attaching value to a business is, to a large extent, related to the growth of its profits. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. This will help him determine if the future of the stock looks bright or worrisome. Has the market assessed NHY’s future prospects? You can find out in our latest Intrinsic Value infographic research report.
Is Norsk Hydro Efficiently Using Its Retained Earnings?
Looking at its three-year median payout rate of 26% (or a retention rate of 74%), which is pretty normal, Norsk Hydro’s decline in earnings is rather disconcerting, as one would expect see good growth when a business keeps a good chunk of its profits. It seems that there could be other reasons for the lack in this regard. For example, the business could be in decline.
Additionally, Norsk Hydro pays dividends over a period of at least ten years, suggesting that sustaining dividend payments is much more important to management, even if it comes at the expense of growing the business. . Looking at the current analyst consensus data, we can see that the company’s future payout ratio is expected to increase to 43% over the next three years. Despite the higher expected payout ratio, the company’s ROE is not expected to change much.
Overall, we think Norsk Hydro certainly has some positive factors to consider. However, although the company has a decent ROE and high profit retention, its profit growth figure is quite disappointing. This suggests that there could be an external threat to the business, hampering growth. That said, looking at current analysts’ estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. To learn more about the latest analyst forecast for the business, check out this visualization of the analyst forecast for the business.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.