TGS ASA's (OB:TGS) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

TGS (OB:TGS) has had a great run on the share market with its stock up by a significant 20% 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. In this article, we decided to focus on TGS' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for TGS

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 TGS is:

1.1% = US$14m ÷ US$1.2b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. So, this means that for every NOK1 of its shareholder's investments, the company generates a profit of NOK0.01.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 TGS' Earnings Growth And 1.1% ROE

It is quite clear that TGS' ROE is rather low. Even compared to the average industry ROE of 8.6%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 19% seen by TGS over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

However, when we compared TGS' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 30% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is TGS fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is TGS Using Its Retained Earnings Effectively?

TGS' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 75% (or a retention ratio of 25%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 4 risks we have identified for TGS visit our risks dashboard for free.

Moreover, TGS has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 54% over the next three years. As a result, the expected drop in TGS' payout ratio explains the anticipated rise in the company's future ROE to 11%, over the same period.

Summary

In total, we would have a hard think before deciding on any investment action concerning TGS. 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. 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. 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.