With its stock down 11% over the past three months, it’s easy to ignore Dow (NYSE:DOW). However, the company’s fundamentals look pretty good and long-term financials usually track future market price movements. Today, we’ll pay particular attention to Dow’s return on equity.

Return on equity, or ROE, is an important factor for a shareholder to consider because it tells them how effectively their capital is being reinvested. In simpler terms, it measures a company’s profitability relative to shareholders’ equity.

Check out our latest analysis for Dow

How do you calculate return on equity?

ROE can be calculated using the following formula:

Return on equity = Net profit (from continuing operations) ÷ Equity

Based on the above formula, the ROE for Dow is:

6.5% = $1.2 billion ÷ $19 billion (based on the trailing twelve months ending June 2024).

The “return” is the profit over the last twelve months. This means that for every dollar of equity the company generated $0.07 in profit.

What does return on equity (ROE) have to do with earnings growth?

So far, we have learned that return on equity (ROE) measures how efficiently a company generates its profits. Depending on how much of those profits the company reinvests or “retains” and how effectively it does so, we can assess a company’s earnings growth potential. Generally speaking, all other things being equal, companies with high return on equity and earnings retention will have a higher growth rate than companies that do not have these characteristics.

Dow’s earnings growth and 6.5% ROE

At first glance, Dow’s ROE does not look very promising. A quick further investigation shows that the company’s ROE does not compare well to the industry average of 9.0%. However, we were pleasantly surprised to see that Dow has been able to increase its net income by a remarkable 21% over the past five years. We assume that other factors could also play a role here. For example, high profit retention or efficient management.

Next, we compared Dow’s net income growth to that of the industry. We were pleased to find that the company’s growth is above the average industry growth of 14%.

The basis for valuing a company depends largely on its earnings growth. The investor should try to determine if the expected earnings growth or expected earnings decline, whichever may be the case, is reflected in the price. This will then help them determine if the stock is positioned for a good or bad future. Is Dow fairly valued compared to other companies? These 3 valuation metrics could help you decide.

The story continues

Does Dow reinvest its profits efficiently?

Dow has a remarkable three-year median payout ratio of 51%, meaning the company retains only 49% of its earnings. This means the company has been able to achieve high earnings growth despite paying out the majority of its earnings to shareholders.

In addition, Dow is committed to continuing to share its profits with shareholders, which we infer from its long five-year dividend payment history. Based on the latest analyst estimates, we found that the company’s future payout ratio is expected to remain stable at 55% over the next three years. However, Dow’s return on equity is expected to increase to 18%, although no change in the payout ratio is expected.

Diploma

Overall, we believe that Dow does have some positive factors to consider. Namely, its high earnings growth. However, we believe that earnings growth could have been even higher if the company had reinvested more of its profits and paid out less dividends. Given these circumstances, recent analyst forecasts show that the company will continue to see earnings growth. You can find more information on the company’s future earnings growth forecasts here. free Read the company’s analyst forecasts report to learn more.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.