Should Weakness in Orora Limited's (ASX:ORA) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at Orora's (ASX:ORA) recent performance, when its stock has declined 18% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Orora'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Orora

How Is ROE Calculated?

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 Orora is:

7.1% = AU$145m ÷ AU$2.0b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.07 in profit.

What Is The Relationship Between ROE And 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. 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.

Orora's Earnings Growth And 7.1% ROE

At first glance, Orora's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 8.3%, we may spare it some thought. On the other hand, Orora reported a moderate 11% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Orora's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 9.0% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Orora is trading on a high P/E or a low P/E, relative to its industry.

Is Orora Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 86% (or a retention ratio of 14%) for Orora suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Orora is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 64% over the next three years. As a result, the expected drop in Orora's payout ratio explains the anticipated rise in the company's future ROE to 12%, over the same period.

Summary

Overall, we feel that Orora certainly does have some positive factors to consider. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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.