Declining Stock and Solid Fundamentals: Is The Market Wrong About SkyCity Entertainment Group Limited (NZSE:SKC)?

It is hard to get excited after looking at SkyCity Entertainment Group's (NZSE:SKC) recent performance, when its stock has declined 7.0% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on SkyCity Entertainment Group's 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for SkyCity Entertainment Group

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for SkyCity Entertainment Group is:

16% = NZ$235m ÷ NZ$1.4b (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.16.

What Has ROE Got To Do With 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

SkyCity Entertainment Group's Earnings Growth And 16% ROE

To begin with, SkyCity Entertainment Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.0%. This certainly adds some context to SkyCity Entertainment Group's exceptional 21% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between SkyCity Entertainment Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 21% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is SKC worth today? The intrinsic value infographic in our free research report helps visualize whether SKC is currently mispriced by the market.

Is SkyCity Entertainment Group Using Its Retained Earnings Effectively?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.

Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 83% of its profits over the next three years. Still, forecasts suggest that SkyCity Entertainment Group's future ROE will drop to 9.2% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that SkyCity Entertainment Group's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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. 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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