Is São Carlos Empreendimentos e Participações S.A.'s (BVMF:SCAR3) Stock Price Struggling As A Result Of Its Mixed Financials?

São Carlos Empreendimentos e Participações (BVMF:SCAR3) has had a rough week with its share price down 7.9%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study São Carlos Empreendimentos e Participações' 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 São Carlos Empreendimentos e Participações

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 São Carlos Empreendimentos e Participações is:

5.6% = R$87m ÷ R$1.6b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every R$1 worth of equity, the company was able to earn R$0.06 in profit.

What Has ROE Got To Do With 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. 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.

São Carlos Empreendimentos e Participações' Earnings Growth And 5.6% ROE

It is hard to argue that São Carlos Empreendimentos e Participações' ROE is much good in and of itself. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 5.9%. Given the low ROE São Carlos Empreendimentos e Participações' five year net income decline of 13% is not surprising.

So, as a next step, we compared São Carlos Empreendimentos e Participações' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 23% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 São Carlos Empreendimentos e Participações is trading on a high P/E or a low P/E, relative to its industry.

Is São Carlos Empreendimentos e Participações Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, São Carlos Empreendimentos e Participações' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, São Carlos Empreendimentos e Participações has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 49% over the next three years. Regardless, the future ROE for São Carlos Empreendimentos e Participações is speculated to rise to 10% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

On the whole, we feel that the performance shown by São Carlos Empreendimentos e Participações can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings 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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