Are Saputo Inc.'s (TSE:SAP) Mixed Financials Driving The Negative Sentiment?

It is hard to get excited after looking at Saputo's (TSE:SAP) recent performance, when its stock has declined 15% over the past month. 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. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Saputo's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Saputo

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 Saputo is:

5.1% = CA$340m ÷ CA$6.6b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.05.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

A Side By Side comparison of Saputo's Earnings Growth And 5.1% ROE

At first glance, Saputo's ROE doesn't look very promising. Next, when compared to the average industry ROE of 8.1%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 10.0% seen by Saputo was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Saputo's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.5% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Saputo's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Saputo Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 46% (that is, a retention ratio of 54%), the fact that Saputo's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Saputo 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 34% over the next three years.

Summary

In total, we're a bit ambivalent about Saputo's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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. 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.