Air Products and Chemicals, Inc.'s (NYSE:APD) Stock Is Going Strong: Is the Market Following Fundamentals?

Air Products and Chemicals (NYSE:APD) has had a great run on the share market with its stock up by a significant 6.8% over the last week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Air Products and Chemicals' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Air Products and Chemicals

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Air Products and Chemicals is:

15% = US$2.2b ÷ US$15b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.15 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Air Products and Chemicals' Earnings Growth And 15% ROE

To start with, Air Products and Chemicals' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 17%. This certainly adds some context to Air Products and Chemicals' moderate 14% net income growth seen over the past five years.

We then compared Air Products and Chemicals' 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 8.2% in the same 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. 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 Air Products and Chemicals is trading on a high P/E or a low P/E, relative to its industry.

Is Air Products and Chemicals Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 60% (or a retention ratio of 40%) for Air Products and Chemicals suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Air Products and Chemicals 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 55%. However, Air Products and Chemicals' ROE is predicted to rise to 18% despite there being no anticipated change in its payout ratio.

Summary

In total, we are pretty happy with Air Products and Chemicals' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.