Tomra Systems ASA's (OB:TOM) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 9.6% over the past month, it is easy to disregard Tomra Systems (OB:TOM). 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 test of how effectively a company is growing its value and managing investors’ money. 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 Tomra Systems

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 Tomra Systems is:

14% = kr798m ÷ kr5.6b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every NOK1 worth of shareholders' equity, the company generated NOK0.14 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. 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 Tomra Systems' Earnings Growth And 14% ROE

At first glance, Tomra Systems seems to have a decent ROE. On comparing with the average industry ROE of 9.8% the company's ROE looks pretty remarkable. Yet, Tomra Systems has posted measly growth of 3.1% over the past five years. That's a bit unexpected from a company which has such a high rate of return. 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 13% 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. Doing so will help them establish if the stock's future looks promising or ominous. Is TOM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Tomra Systems Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 52% (that is, the company retains only 48% of its income) over the past three years for Tomra Systems suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Tomra Systems 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 50%. Regardless, the future ROE for Tomra Systems is predicted to rise to 25% 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, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. 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.

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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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