Most readers would already be aware that Kongsberg Gruppen's (OB:KOG) stock increased significantly by 29% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Kongsberg Gruppen'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.
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 Kongsberg Gruppen is:
9.2% = kr1.4b ÷ kr15b (Based on the trailing twelve months to September 2020).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every NOK1 worth of equity, the company was able to earn NOK0.09 in profit.
What Has ROE Got To Do With 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 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.
Kongsberg Gruppen's Earnings Growth And 9.2% ROE
On the face of it, Kongsberg Gruppen'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 11%. Having said that, Kongsberg Gruppen has shown a modest net income growth of 8.1% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Kongsberg Gruppen's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 10% in the same period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is KOG fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Kongsberg Gruppen Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 64% (or a retention ratio of 36%) for Kongsberg Gruppen suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Additionally, Kongsberg Gruppen has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 48% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 15%, over the same period.
In total, we're a bit ambivalent about Kongsberg Gruppen's performance. Although the company has shown a fair bit of growth in earnings, the reinvestment rate is low. Meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits and reinvesting that at a higher rate of return. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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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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