Subsea 7 S.A.'s (OB:SUBC) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Subsea 7 (OB:SUBC) has had a great run on the share market with its stock up by a significant 10% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study Subsea 7's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Subsea 7

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 Subsea 7 is:

0.8% = US$36m ÷ US$4.5b (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each NOK1 of shareholders' capital it has, the company made NOK0.01 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. 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.

Subsea 7's Earnings Growth And 0.8% ROE

As you can see, Subsea 7's ROE looks pretty weak. Even compared to the average industry ROE of 10%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 31% seen by Subsea 7 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 instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Subsea 7's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 27% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is SUBC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Subsea 7 Making Efficient Use Of Its Profits?

Subsea 7's very high three-year median payout ratio of 106% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move.

Additionally, Subsea 7 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 30% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 9.1%, over the same period.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Subsea 7. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. 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 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.