Is Select Harvests Limited's (ASX:SHV) Recent Price Movement Underpinned By Its Weak Fundamentals?

It is hard to get excited after looking at Select Harvests' (ASX:SHV) recent performance, when its stock has declined 16% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. 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 Select Harvests' ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Select Harvests

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 Select Harvests is:

6.2% = AU$25m ÷ AU$405m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.06 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Select Harvests' Earnings Growth And 6.2% ROE

On the face of it, Select Harvests' ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 4.8% doesn't go unnoticed by us. But then again, seeing that Select Harvests' net income shrunk at a rate of 2.7% in the past five years, makes us think again. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the shrinking earnings.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 1.3% in the same period, we still found Select Harvests' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Select Harvests''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Select Harvests Efficiently Re-investing Its Profits?

Select Harvests has a high three-year median payout ratio of 56% (that is, it is retaining 44% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 3 risks we have identified for Select Harvests visit our risks dashboard for free.

In addition, Select Harvests 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. 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 53%. However, Select Harvests' ROE is predicted to rise to 9.7% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that the performance shown by Select Harvests can be open to many interpretations. On the one hand, the company does have a decent rate of return, however, its earnings growth number is quite disappointing and as discussed earlier, the low retained earnings is hampering the growth. 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 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.
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