Do Fundamentals Have Any Role To Play In Driving Topdanmark A/S' (CPH:TOP) Stock Up Recently?

By
Simply Wall St
Published
April 11, 2022
CPSE:TOP
Source: Shutterstock

Topdanmark's (CPH:TOP) stock is up by 5.6% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Topdanmark's ROE in this article.

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.

See our latest analysis for Topdanmark

How To Calculate Return On Equity?

The formula for return on equity is:

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

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

29% = kr.2.1b ÷ kr.7.4b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every DKK1 of its shareholder's investments, the company generates a profit of DKK0.29.

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Topdanmark's Earnings Growth And 29% ROE

First thing first, we like that Topdanmark has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 10% also doesn't go unnoticed by us. Given the circumstances, we can't help but wonder why Topdanmark saw little to no growth 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.

Next, on comparing with the industry net income growth, we found that Topdanmark's reported growth was lower than the industry growth of 7.5% in the same period, which is not something we like to see.

past-earnings-growth
CPSE:TOP Past Earnings Growth April 11th 2022

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is TOP fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Topdanmark Making Efficient Use Of 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.

Additionally, Topdanmark has paid dividends over a period of four years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 99% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

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. 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. 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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