Acadian Timber Corp.'s (TSE:ADN) Financial Prospects Don't Look Very Positive: Could It Mean A Stock Price Drop In The Future?

Most readers would already know that Acadian Timber's (TSE:ADN) stock increased by 1.9% over the past three months. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Particularly, we will be paying attention to Acadian Timber's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Acadian Timber

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 Acadian Timber is:

8.1% = CA$23m ÷ CA$283m (Based on the trailing twelve months to September 2020).

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$0.08.

What Is The Relationship Between ROE And 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 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.

Acadian Timber's Earnings Growth And 8.1% ROE

On the face of it, Acadian Timber's ROE is not much to talk about. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Acadian Timber's five year net income decline of 5.3% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

With the industry earnings declining at a rate of 4.4% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

Earnings growth is a huge factor in stock valuation. 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 Acadian Timber's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Acadian Timber Efficiently Re-investing Its Profits?

Acadian Timber's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 83% (or a retention ratio of 17%). 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. Our risks dashboard should have the 2 risks we have identified for Acadian Timber.

Moreover, Acadian Timber 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 136% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 6.5%) over the same period.

Conclusion

On the whole, Acadian Timber's performance is quite a big let-down. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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