Do Its Financials Have Any Role To Play In Driving Scandinavian Tobacco Group A/S' (CPH:STG) Stock Up Recently?

Most readers would already be aware that Scandinavian Tobacco Group's (CPH:STG) stock increased significantly by 21% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Scandinavian Tobacco Group's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Scandinavian Tobacco Group

How Do You 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 Scandinavian Tobacco Group is:

11% = kr.982m ÷ kr.8.8b (Based on the trailing twelve months to March 2021).

The 'return' refers to a company's earnings over the last year. So, this means that for every DKK1 of its shareholder's investments, the company generates a profit of DKK0.11.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Scandinavian Tobacco Group's Earnings Growth And 11% ROE

To begin with, Scandinavian Tobacco Group seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Scandinavian Tobacco Group's decent returns aren't reflected in Scandinavian Tobacco Group'smediocre five year net income growth average of 4.7%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Scandinavian Tobacco Group's reported growth was lower than the industry growth of 6.9% in the same period, 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. If you're wondering about Scandinavian Tobacco Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Scandinavian Tobacco Group Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 85% (or a retention ratio of 15%), most of Scandinavian Tobacco Group's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Scandinavian Tobacco Group has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 53% over the next three years. As a result, the expected drop in Scandinavian Tobacco Group's payout ratio explains the anticipated rise in the company's future ROE to 15%, over the same period.

Conclusion

In total, it does look like Scandinavian Tobacco Group has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.