Dow Inc. (NYSE:DOW) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

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With its stock down 12% over the past three months, it is easy to disregard Dow (NYSE:DOW). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Dow’s ROE.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.

View our latest analysis for Dow

How Do You 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 Dow is:

6.7% = US$1.3b ÷ US$19b (Based on the trailing twelve months to March 2024).

The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.07 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. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. 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 Dow’s Earnings Growth And 6.7% ROE

On the face of it, Dow’s ROE is not much to talk about. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 10% either. Despite this, surprisingly, Dow saw an exceptional 23% net income growth over the past five years. We reckon that there could be other factors at play here. Such as – high earnings retention or an efficient management in place.

As a next step, we compared Dow’s net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 14%.

past-earnings-growth

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. 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 Dow is trading on a high P/E or a low P/E, relative to its industry.

Is Dow Efficiently Re-investing Its Profits?

Dow’s significant three-year median payout ratio of 51% (where it is retaining only 49% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Moreover, Dow is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 59% of its profits over the next three years. However, Dow’s ROE is predicted to rise to 18% despite there being no anticipated change in its payout ratio.

Summary

Overall, we feel that Dow certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. We also studied the latest analyst forecasts and found that the company’s earnings growth is expected be similar to its current growth rate. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.

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