Swisscom AG's (VTX:SCMN) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Swisscom (VTX:SCMN) has had a rough three months with its share price down 9.3%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Swisscom's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Swisscom

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Swisscom is:

14% = CHF1.7b ÷ CHF12b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. That means that for every CHF1 worth of shareholders' equity, the company generated CHF0.14 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 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 Swisscom's Earnings Growth And 14% ROE

At first glance, Swisscom seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. However, we are curious as to how Swisscom's decent returns still resulted in flat growth for Swisscom in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Swisscom's reported growth was lower than the industry growth of 9.4% over the last few years, which is not something we like to see.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is SCMN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Swisscom Using Its Retained Earnings Effectively?

Swisscom has a high three-year median payout ratio of 68% (or a retention ratio of 32%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Moreover, Swisscom 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 79%. As a result, Swisscom's ROE is not expected to change by much either, which we inferred from the analyst estimate of 13% for future ROE.

Summary

In total, it does look like Swisscom has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink slightly 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.