Most readers would already be aware that Skipper's (NSE:SKIPPER) stock increased significantly by 29% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Skipper's ROE today.
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 Skipper is:
4.9% = ₹337m ÷ ₹6.9b (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.05 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
Skipper's Earnings Growth And 4.9% ROE
As you can see, Skipper's ROE looks pretty weak. Even when compared to the industry average of 6.5%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 22% seen by Skipper over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Skipper'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 10% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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 Skipper fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Skipper Efficiently Re-investing Its Profits?
When we piece together Skipper's low three-year median payout ratio of 8.2% (where it is retaining 92% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Skipper has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.
Overall, we have mixed feelings about Skipper. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 4 risks we have identified for Skipper visit our risks dashboard for free.
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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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