UPM-Kymmene Oyj's (HEL:UPM) Stock Been Rising But Financials Look Weak: Should Shareholders Be Worried?

By
Simply Wall St
Published
July 19, 2021
HLSE:UPM
Source: Shutterstock

UPM-Kymmene Oyj's (HEL:UPM) stock is up by 4.4% over the past month. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Particularly, we will be paying attention to UPM-Kymmene Oyj's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for UPM-Kymmene Oyj

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 UPM-Kymmene Oyj is:

6.5% = €603m ÷ €9.3b (Based on the trailing twelve months to March 2021).

The 'return' is the income the business earned over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.06.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 UPM-Kymmene Oyj's Earnings Growth And 6.5% ROE

On the face of it, UPM-Kymmene Oyj's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.4%. But UPM-Kymmene Oyj saw a five year net income decline of 2.5% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared UPM-Kymmene Oyj's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 6.3% in the same period.

past-earnings-growth
HLSE:UPM Past Earnings Growth July 19th 2021

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about UPM-Kymmene Oyj's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is UPM-Kymmene Oyj Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 59% (implying that 41% of the profits are retained), most of UPM-Kymmene Oyj's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, UPM-Kymmene Oyj has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 66%. Still, forecasts suggest that UPM-Kymmene Oyj's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, UPM-Kymmene Oyj's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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