Does Kendrion N.V.'s (AMS:KENDR) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Kendrion (AMS:KENDR) has had a great run on the share market with its stock up by a significant 15% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Kendrion's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Kendrion

How Is ROE Calculated?

The formula for ROE is:

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

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

0.8% = €1.6m ÷ €205m (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 €1 of shareholders' capital it has, the company made €0.01 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Kendrion's Earnings Growth And 0.8% ROE

It is hard to argue that Kendrion's ROE is much good in and of itself. Even compared to the average industry ROE of 7.3%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 19% seen by Kendrion was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

As a next step, we compared Kendrion's performance with the industry and found thatKendrion's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.8% in the same period, which is a slower than the company.

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 Kendrion fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kendrion Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 73% (implying that 27% of the profits are retained), most of Kendrion'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 3 risks we have identified for Kendrion by visiting our risks dashboard for free on our platform here.

In addition, Kendrion 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 45% over the next three years. The fact that the company's ROE is expected to rise to 6.7% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on Kendrion. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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