Will Weakness in SalMar ASA's (OB:SALM) Stock Prove Temporary Given Strong Fundamentals?

July 04, 2021
  •  Updated
October 02, 2022
OB:SALM
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With its stock down 11% over the past month, it is easy to disregard SalMar (OB:SALM). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to SalMar's ROE today.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for SalMar

How To Calculate Return On Equity?

Return on equity 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:

21% = kr2.4b ÷ kr12b (Based on the trailing twelve months to March 2021).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NOK1 of shareholders' capital it has, the company made NOK0.21 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 21% ROE

To begin with, SalMar seems to have a respectable ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Despite this, SalMar's five year net income growth was quite low averaging at only 3.8%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. 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 the growth figure reported by SalMar compares quite favourably to the industry average, which shows a decline of 9.1% in the same period.

past-earnings-growth
OB:SALM Past Earnings Growth July 5th 2021

Earnings growth is a huge factor in stock valuation. 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. Is SALM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is SalMar Using Its Retained Earnings Effectively?

SalMar has a three-year median payout ratio of 73% (implying that it keeps only 27% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

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. 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 81%. Regardless, the future ROE for SalMar is predicted to rise to 29% despite there being not much change expected in its payout ratio.

Conclusion

In total, we are pretty happy with SalMar's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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