Are Koninklijke Philips N.V.'s (AMS:PHIA) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

It is hard to get excited after looking at Koninklijke Philips' (AMS:PHIA) recent performance, when its stock has declined 19% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Koninklijke Philips' ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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How To Calculate Return On Equity?

ROE 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 Koninklijke Philips is:

2.0% = €237m ÷ €12b (Based on the trailing twelve months to March 2025).

The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.02 in profit.

See our latest analysis for Koninklijke Philips

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. 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.

Koninklijke Philips' Earnings Growth And 2.0% ROE

It is quite clear that Koninklijke Philips' ROE is rather low. Even compared to the average industry ROE of 8.7%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 48% seen by Koninklijke Philips was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Koninklijke Philips' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.9% over the last few years.

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). Doing so will help them establish if the stock's future looks promising or ominous. Is Koninklijke Philips fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Koninklijke Philips Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 47% (or a retention ratio of 53%) which is pretty normal, Koninklijke Philips' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Koninklijke Philips 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. 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%. Still, forecasts suggest that Koninklijke Philips' future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that the performance shown by Koninklijke Philips can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.