Declining Stock and Solid Fundamentals: Is The Market Wrong About TORM plc (CPH:TRMD A)?

TORM (CPH:TRMD A) has had a rough three months with its share price down 32%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on TORM's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for TORM

How To Calculate Return On Equity?

ROE 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 TORM is:

35% = US$719m ÷ US$2.0b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each DKK1 of shareholders' capital it has, the company made DKK0.35 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.

TORM's Earnings Growth And 35% ROE

Firstly, we acknowledge that TORM has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. Under the circumstances, TORM's considerable five year net income growth of 46% was to be expected.

Next, on comparing with the industry net income growth, we found that TORM's growth is quite high when compared to the industry average growth of 29% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about TORM's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is TORM Efficiently Re-investing Its Profits?

TORM has a significant three-year median payout ratio of 71%, meaning the company only retains 29% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Besides, TORM has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 87% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 18% over the same period.

Summary

In total, we are pretty happy with TORM's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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. 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.