Does Aamal Company Q.P.S.C.'s (DSM:AHCS) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Aamal Company Q.P.S.C's (DSM:AHCS) stock increased significantly by 7.6% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Aamal Company Q.P.S.C's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Aamal Company Q.P.S.C

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 Aamal Company Q.P.S.C is:

3.1% = ر.ق242m ÷ ر.ق7.8b (Based on the trailing twelve months to September 2021).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every QAR1 worth of equity, the company was able to earn QAR0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Aamal Company Q.P.S.C's Earnings Growth And 3.1% ROE

As you can see, Aamal Company Q.P.S.C's ROE looks pretty weak. Even compared to the average industry ROE of 18%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 23% seen by Aamal Company Q.P.S.C was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

With the industry earnings declining at a rate of 20% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Aamal Company Q.P.S.C's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Aamal Company Q.P.S.C Efficiently Re-investing Its Profits?

With a three-year median payout ratio as high as 102%,Aamal Company Q.P.S.C's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend higher than reported profits is not a sustainable move.

Additionally, Aamal Company Q.P.S.C has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 74% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 5.0%, over the same period.

Conclusion

Overall, we would be extremely cautious before making any decision on Aamal Company Q.P.S.C. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. 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. 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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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.