Are Tomra Systems ASA's (OB:TOM) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

Tomra Systems (OB:TOM) has had a rough three months with its share price down 8.6%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Tomra Systems' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Tomra Systems

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 Tomra Systems is:

12% = kr744m ÷ kr6.2b (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 NOK1 worth of equity, the company was able to earn NOK0.12 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. 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.

Tomra Systems' Earnings Growth And 12% ROE

To begin with, Tomra Systems seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 10.0%. Despite this, Tomra Systems' five year net income growth was quite low averaging at only 3.8%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Tomra Systems' reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Tomra Systems is trading on a high P/E or a low P/E, relative to its industry.

Is Tomra Systems Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 50% (or a retention ratio of 50% over the past three years, Tomra Systems has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Tomra Systems has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings 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 58%. Regardless, the future ROE for Tomra Systems is predicted to rise to 17% despite there being not much change expected in its payout ratio.

Summary

In total, it does look like Tomra Systems has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

When trading Tomra Systems or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.