Will Weakness in West Pharmaceutical Services, Inc.'s (NYSE:WST) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 43% over the past three months, it is easy to disregard West Pharmaceutical Services (NYSE:WST). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to West Pharmaceutical Services' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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How Is ROE Calculated?

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 West Pharmaceutical Services is:

18% = US$493m ÷ US$2.7b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.18.

View our latest analysis for West Pharmaceutical Services

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

West Pharmaceutical Services' Earnings Growth And 18% ROE

To begin with, West Pharmaceutical Services seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This probably laid the ground for West Pharmaceutical Services' moderate 10% net income growth seen over the past five years.

We then compared West Pharmaceutical Services' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 5.5% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is WST fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is West Pharmaceutical Services Efficiently Re-investing Its Profits?

West Pharmaceutical Services' three-year median payout ratio to shareholders is 10.0% (implying that it retains 90% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, West Pharmaceutical Services is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 11%. As a result, West Pharmaceutical Services' ROE is not expected to change by much either, which we inferred from the analyst estimate of 17% for future ROE.

Summary

In total, we are pretty happy with West Pharmaceutical Services' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.