Is Arabian Drilling Company's (TADAWUL:2381) Recent Price Movement Underpinned By Its Weak Fundamentals?

Arabian Drilling (TADAWUL:2381) has had a rough three months with its share price down 14%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Arabian Drilling's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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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 Arabian Drilling is:

5.4% = ر.س321m ÷ ر.س5.9b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each SAR1 of shareholders' capital it has, the company made SAR0.05 in profit.

Check out our latest analysis for Arabian Drilling

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Arabian Drilling's Earnings Growth And 5.4% ROE

It is quite clear that Arabian Drilling's ROE is rather low. Even compared to the average industry ROE of 8.5%, the company's ROE is quite dismal. Arabian Drilling was still able to see a decent net income growth of 11% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Arabian Drilling's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 20% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is 2381 worth today? The intrinsic value infographic in our free research report helps visualize whether 2381 is currently mispriced by the market.

Is Arabian Drilling Making Efficient Use Of Its Profits?

Arabian Drilling has a significant three-year median payout ratio of 74%, meaning that it is left with only 26% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Along with seeing a growth in earnings, Arabian Drilling only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 75% of its profits over the next three years. Still, forecasts suggest that Arabian Drilling's future ROE will rise to 10% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that the performance shown by Arabian Drilling can be open to many interpretations. While no doubt its earnings growth is pretty respectable, the low profit retention could mean that the company's earnings growth could have been higher, had it been paying reinvesting a higher portion of its profits. An improvement in its ROE could also help future earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.