Does The Market Have A Low Tolerance For Topdanmark A/S' (CPH:TOP) Mixed Fundamentals?

It is hard to get excited after looking at Topdanmark's (CPH:TOP) recent performance, when its stock has declined 16% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Topdanmark's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Topdanmark

How Do You Calculate Return On Equity?

Return on equity 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:

16% = kr.985m ÷ kr.6.3b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each DKK1 of shareholders' capital it has, the company made DKK0.16 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. 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.

Topdanmark's Earnings Growth And 16% ROE

At first glance, Topdanmark seems to have a decent ROE. On comparing with the average industry ROE of 9.5% the company's ROE looks pretty remarkable. For this reason, Topdanmark's five year net income decline of 2.2% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

So, as a next step, we compared Topdanmark's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 6.2% in the same period.

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. 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?

With a high three-year median payout ratio of 90% (implying that 9.9% of the profits are retained), most of Topdanmark's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 2 risks we have identified for Topdanmark by visiting our risks dashboard for free on our platform here.

In addition, Topdanmark has been paying dividends over a period of three years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 105%. Regardless, the future ROE for Topdanmark is predicted to rise to 25% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, we feel that the performance shown by Topdanmark can be open to many interpretations. In spite of the high ROE, the company has failed to see growth in its earnings due to it paying out most of its profits as dividend, with almost nothing left to invest into its own business. 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. 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. 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.
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