Krynica Vitamin (WSE:KVT) has had a great run on the share market with its stock up by a significant 40% over the last three months. We wonder if and what role the company’s financials play in that price change as a company’s long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Krynica Vitamin’s ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
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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 Krynica Vitamin is:
13% = zł7.0m ÷ zł55m (Based on the trailing twelve months to March 2020).
The ‘return’ is the income the business earned over the last year. Another way to think of that is that for every PLN1 worth of equity, the company was able to earn PLN0.13 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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. 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.
Krynica Vitamin’s Earnings Growth And 13% ROE
At first glance, Krynica Vitamin seems to have a decent ROE. Especially when compared to the industry average of 9.4% the company’s ROE looks pretty impressive. As you might expect, the 22% net income decline reported by Krynica Vitamin is a bit of a surprise. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared Krynica Vitamin’s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.8% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Krynica Vitamin is trading on a high P/E or a low P/E, relative to its industry.
Is Krynica Vitamin Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 60% (implying that 40% of the profits are retained), most of Krynica Vitamin’s profits are being paid to shareholders, which explains the company’s shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 5 risks we have identified for Krynica Vitamin.
In addition, Krynica Vitamin has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.
Conclusion
Overall, we feel that Krynica Vitamin certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren’t reaping the benefits of the high rate of return. So far, we’ve only made a quick discussion around the company’s earnings growth. So it may be worth checking this free detailed graph of Krynica Vitamin’s past earnings, as well as revenue and cash flows to get a deeper insight into the company’s performance.
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