Is The Market Rewarding SkyCity Entertainment Group Limited (NZSE:SKC) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

SkyCity Entertainment Group (NZSE:SKC) has had a rough three months with its share price down 14%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on SkyCity Entertainment Group'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.

Check out our latest analysis for SkyCity Entertainment Group

How Is ROE Calculated?

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 SkyCity Entertainment Group is:

0.5% = NZ$8.0m ÷ NZ$1.5b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.01 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.

A Side By Side comparison of SkyCity Entertainment Group's Earnings Growth And 0.5% ROE

It is quite clear that SkyCity Entertainment Group's ROE is rather low. Even when compared to the industry average of 6.5%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 41% seen by SkyCity Entertainment Group over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 14% over the last few years, we found that SkyCity Entertainment Group's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for SKC? You can find out in our latest intrinsic value infographic research report.

Is SkyCity Entertainment Group Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 44% (or a retention ratio of 56%) which is pretty normal, SkyCity Entertainment Group's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, SkyCity Entertainment Group 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 80% over the next three years. Still, forecasts suggest that SkyCity Entertainment Group's future ROE will rise to 10.0% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

On the whole, we feel that the performance shown by SkyCity Entertainment Group can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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.