Ramada Investimentos e Industria, S.A. (ELI:RAM) Stock's On A Decline: Are Poor Fundamentals The Cause?

With its stock down 3.9% over the past three months, it is easy to disregard Ramada Investimentos e Industria (ELI:RAM). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to Ramada Investimentos e Industria's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Ramada Investimentos e Industria

How Is ROE Calculated?

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 Ramada Investimentos e Industria is:

5.3% = €6.8m ÷ €127m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.05 in profit.

What Has ROE Got To Do With 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Ramada Investimentos e Industria's Earnings Growth And 5.3% ROE

At first glance, Ramada Investimentos e Industria's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. For this reason, Ramada Investimentos e Industria's five year net income decline of 8.5% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared Ramada Investimentos e Industria's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 16% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Ramada Investimentos e Industria is trading on a high P/E or a low P/E, relative to its industry.

Is Ramada Investimentos e Industria Using Its Retained Earnings Effectively?

With a three-year median payout ratio as high as 472%,Ramada Investimentos e Industria's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Its usually very hard to sustain dividend payments that are higher than reported profits. Our risks dashboard should have the 4 risks we have identified for Ramada Investimentos e Industria.

In addition, Ramada Investimentos e Industria has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 48% over the next three years. Regardless, the future ROE for Ramada Investimentos e Industria is predicted to decline to 3.9% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Conclusion

Overall, we would be extremely cautious before making any decision on Ramada Investimentos e Industria. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. In addition, on studying the latest analyst forecasts, we found that the company's earnings are expected to continue to shrink. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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