PrairieSky Royalty (TSE:PSK) has had a great run on the share market with its stock up by a significant 29% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to PrairieSky Royalty’s ROE today.
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.
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 PrairieSky Royalty is:
3.8% = CA$94m ÷ CA$2.4b (Based on the trailing twelve months to March 2020).
The ‘return’ is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.04 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. 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.
A Side By Side comparison of PrairieSky Royalty’s Earnings Growth And 3.8% ROE
On the face of it, PrairieSky Royalty’s ROE is not much to talk about. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 8.3% either. Given the circumstances, the significant decline in net income by 7.6% seen by PrairieSky Royalty over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company’s earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared PrairieSky Royalty’s 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 25% in the same period.
Earnings growth is a huge factor in stock valuation. 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. What is PSK worth today? The intrinsic value infographic in our free research report helps visualize whether PSK is currently mispriced by the market.
Is PrairieSky Royalty Efficiently Re-investing Its Profits?
PrairieSky Royalty’s very high three-year median payout ratio of 179% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company’s shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. To know the 3 risks we have identified for PrairieSky Royalty visit our risks dashboard for free.
Additionally, PrairieSky Royalty has paid dividends over a period of six years, which means that the company’s management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 103% over the next three years.
In total, we would have a hard think before deciding on any investment action concerning PrairieSky Royalty. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Moreover, after studying current analyst estimates, we discovered that the company’s earnings are expected to continue to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.