It is hard to get excited after looking at Topdanmark's (CPH:TOP) recent performance, when its stock has declined 4.5% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Topdanmark's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You 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 Topdanmark is:
18% = kr.1.2b ÷ kr.6.8b (Based on the trailing twelve months to March 2023).
The 'return' is the yearly profit. That means that for every DKK1 worth of shareholders' equity, the company generated DKK0.18 in profit.
What Has ROE Got To Do With 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.
Topdanmark's Earnings Growth And 18% ROE
To start with, Topdanmark's ROE looks acceptable. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for Topdanmark 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. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
We then compared Topdanmark's net income growth with the industry and found that the average industry growth rate was 8.0% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is TOP worth today? The intrinsic value infographic in our free research report helps visualize whether TOP is currently mispriced by the market.
Is Topdanmark Efficiently Re-investing Its Profits?
Topdanmark has a high three-year median payout ratio of 81% (or a retention ratio of 19%), 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, Topdanmark 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 107% over the next three years. Still, forecasts suggest that Topdanmark's future ROE will rise to 27% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.
In total, it does look like Topdanmark 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow 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.