Is Weakness In TORM plc (CPH:TRMD A) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

TORM (CPH:TRMD A) has had a rough three months with its share price down 28%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for TORM

How To Calculate Return On Equity?

The formula for ROE is:

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

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

43% = US$706m ÷ US$1.7b (Based on the trailing twelve months to March 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every DKK1 worth of equity, the company was able to earn DKK0.43 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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 TORM's Earnings Growth And 43% ROE

To begin with, TORM has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. As a result, TORM's exceptional 52% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared TORM's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 22%.

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. 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 TORM is trading on a high P/E or a low P/E, relative to its industry.

Is TORM Making Efficient Use Of Its Profits?

TORM has a three-year median payout ratio of 50% (where it is retaining 50% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like TORM is reinvesting its earnings efficiently.

Besides, TORM has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 84% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 25%, over the same period.

Summary

In total, we are pretty happy with TORM's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink 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. 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.