Sphera Franchise Group S.A. (BVB:SFG) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

Sphera Franchise Group (BVB:SFG) has had a rough month with its share price down 4.5%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Sphera Franchise Group's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Sphera Franchise Group

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 Sphera Franchise Group is:

29% = RON42m ÷ RON146m (Based on the trailing twelve months to March 2020).

The 'return' is the yearly profit. So, this means that for every RON1 of its shareholder's investments, the company generates a profit of RON0.29.

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. 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 Sphera Franchise Group's Earnings Growth And 29% ROE

To begin with, Sphera Franchise Group has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 8.7% which is quite remarkable. For this reason, Sphera Franchise Group's five year net income decline of 14% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

However, when we compared Sphera Franchise Group'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. Is SFG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sphera Franchise Group Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 65% (implying that 35% of the profits are retained), most of Sphera Franchise Group's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 2 risks we have identified for Sphera Franchise Group by visiting our risks dashboard for free on our platform here.

In addition, Sphera Franchise Group only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. 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 60%. Accordingly, forecasts suggest that Sphera Franchise Group's future ROE will be 30% which is again, similar to the current ROE.

Summary

On the whole, we do feel that Sphera Franchise Group has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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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