Does SalMar ASA's (OB:SALM) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that SalMar's (OB:SALM) stock increased significantly by 11% over the past month. 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 SalMar's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for SalMar

How To 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 SalMar is:

8.0% = kr1.9b ÷ kr24b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each NOK1 of shareholders' capital it has, the company made NOK0.08 in profit.

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.

SalMar's Earnings Growth And 8.0% ROE

At first glance, SalMar's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 5.6% which we definitely can't overlook. But then again, seeing that SalMar's net income shrunk at a rate of 5.9% in the past five years, makes us think again. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to shrink.

However, when we compared SalMar's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.2% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 SalMar is trading on a high P/E or a low P/E, relative to its industry.

Is SalMar Using Its Retained Earnings Effectively?

SalMar's 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 99% (or a retention ratio of 1.3%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 4 risks we have identified for SalMar by visiting our risks dashboard for free on our platform here.

Additionally, SalMar 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 73% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 28%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on SalMar. The company has shown a disappointing growth in its earnings as a result of it retaining little to almost none of its profits. So, the decent ROE it does have, is not much useful to investors given that the company is reinvesting very little into its business. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.