Does Bega Cheese Limited's (ASX:BGA) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Bega Cheese (ASX:BGA) has had a great run on the share market with its stock up by a significant 8.5% over the last week. 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. Specifically, we decided to study Bega Cheese's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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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 Bega Cheese is:

3.3% = AU$34m ÷ AU$1.0b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.03 in profit.

View our latest analysis for Bega Cheese

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Bega Cheese's Earnings Growth And 3.3% ROE

As you can see, Bega Cheese's ROE looks pretty weak. Even when compared to the industry average of 5.0%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 39% seen by Bega Cheese over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

As a next step, we compared Bega Cheese's performance with the industry and found thatBega Cheese's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 2.0% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Bega Cheese's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Bega Cheese Using Its Retained Earnings Effectively?

Bega Cheese's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 70% (or a retention ratio of 30%). With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, Bega Cheese has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 61%. Still, forecasts suggest that Bega Cheese's future ROE will rise to 8.1% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we would have a hard think before deciding on any investment action concerning Bega Cheese. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.