Most readers would already be aware that Sensient Technologies' (NYSE:SXT) stock increased significantly by 13% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Sensient Technologies' ROE in this article.

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.

See our latest analysis for Sensient Technologies

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Sensient Technologies is:

8.2% = US$89m ÷ US$1.1b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. 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. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Sensient Technologies' Earnings Growth And 8.2% ROE

At first glance, Sensient Technologies' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 10%. On the other hand, Sensient Technologies reported a fairly low 3.1% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

As a next step, we compared Sensient Technologies' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 9.3% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Sensient Technologies''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sensient Technologies Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 54% (or a retention ratio of 46%), most of Sensient Technologies' profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Sensient Technologies 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 over the next three years is expected to be approximately 44%. Regardless, the future ROE for Sensient Technologies is predicted to rise to 13% despite there being not much change expected in its payout ratio.

Summary

On the whole, Sensient Technologies' performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.