Saudi Marketing Company (TADAWUL:4006) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Most readers would already be aware that Saudi Marketing's (TADAWUL:4006) stock increased significantly by 33% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Saudi Marketing's ROE.

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 Saudi Marketing

How Do You 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 Saudi Marketing is:

6.4% = ر.س39m ÷ ر.س612m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every SAR1 worth of shareholders' equity, the company generated SAR0.06 in profit.

What Is The Relationship Between ROE And 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 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.

A Side By Side comparison of Saudi Marketing's Earnings Growth And 6.4% ROE

It is hard to argue that Saudi Marketing's ROE is much good in and of itself. Even compared to the average industry ROE of 9.2%, the company's ROE is quite dismal. For this reason, Saudi Marketing's five year net income decline of 47% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Saudi Marketing's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.0% 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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Saudi Marketing's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Saudi Marketing Efficiently Re-investing Its Profits?

Saudi Marketing doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Summary

On the whole, we feel that the performance shown by Saudi Marketing can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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