Are Poor Financial Prospects Dragging Down Sunland Group Limited (ASX:SDG Stock?

By
Simply Wall St
Published
May 28, 2021
ASX:SDG

It is hard to get excited after looking at Sunland Group's (ASX:SDG) recent performance, when its stock has declined 7.7% over the past three months. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Sunland Group'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Sunland Group

How To 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 Sunland Group is:

3.0% = AU$10m ÷ AU$345m (Based on the trailing twelve months to December 2020).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.03.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Sunland Group's Earnings Growth And 3.0% ROE

It is hard to argue that Sunland Group's ROE is much good in and of itself. Not just that, even compared to the industry average of 5.1%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 25% seen by Sunland Group 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 example, the business has allocated capital poorly, or that the company has a very high payout ratio.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 9.2% in the same period, we found that Sunland Group's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

past-earnings-growth
ASX:SDG Past Earnings Growth May 28th 2021

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Sunland Group is trading on a high P/E or a low P/E, relative to its industry.

Is Sunland Group Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 58% (implying that 42% of the profits are retained), most of Sunland Group's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 3 risks we have identified for Sunland Group visit our risks dashboard for free.

In addition, Sunland Group has been paying dividends over a period of eight years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 40% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 11%, over the same period.

Conclusion

Overall, we would be extremely cautious before making any decision on Sunland Group. 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 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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