Victrex plc's (LON:VCT) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

editorial-team@simplywallst.com (Simply Wall St)

Mon, Jan 27, 2025, 10:07 PM 4 min read

Most readers would already be aware that Victrex's (LON:VCT) stock increased significantly by 17% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Victrex's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 Victrex

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Victrex is:

3.4% = UK£16m ÷ UK£462m (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.03 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.

Victrex's Earnings Growth And 3.4% ROE

It is hard to argue that Victrex's ROE is much good in and of itself. Even compared to the average industry ROE of 7.9%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 15% seen by Victrex was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Victrex's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.7% in the same period. This is quite worrisome.

past-earnings-growth — LSE:VCT Past Earnings Growth January 28th 2025

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is VCT worth today? The intrinsic value infographic in our free research report helps visualize whether VCT is currently mispriced by the market.

Is Victrex Efficiently Re-investing Its Profits?

Victrex has a high three-year median payout ratio of 74% (that is, it is retaining 26% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Victrex.

In addition, Victrex has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 72%. Regardless, the future ROE for Victrex is predicted to rise to 15% despite there being not much change expected in its payout ratio.

Summary

In total, we would have a hard think before deciding on any investment action concerning Victrex. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.