Ridley (ASX:RIC) has had a great run on the share market with its stock up by a significant 30% 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. In this article, we decided to focus on Ridley's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Ridley is:
0.9% = AU$2.5m ÷ AU$276m (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.01 in profit.
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. 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. 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.
Ridley's Earnings Growth And 0.9% ROE
It is hard to argue that Ridley's ROE is much good in and of itself. Even when compared to the industry average of 5.3%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 36% seen by Ridley was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
As a next step, we compared Ridley's performance with the industry and found thatRidley's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 2.7% 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Ridley's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Ridley Efficiently Re-investing Its Profits?
While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.
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 59%. Still, forecasts suggest that Ridley's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.
Overall, we would be extremely cautious before making any decision on Ridley. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. 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. 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.
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