Saudia Dairy & Foodstuff's (TADAWUL:2270) stock is up by a considerable 11% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Saudia Dairy & Foodstuff'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
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 Saudia Dairy & Foodstuff is:
17% = ر.س279m ÷ ر.س1.6b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every SAR1 worth of equity, the company was able to earn SAR0.17 in profit.
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. 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.
A Side By Side comparison of Saudia Dairy & Foodstuff's Earnings Growth And 17% ROE
At first glance, Saudia Dairy & Foodstuff seems to have a decent ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Despite this, Saudia Dairy & Foodstuff's five year net income growth was quite flat over the past five years. Therefore, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.
As a next step, we compared Saudia Dairy & Foodstuff's performance with the industry and discovered the industry has shrunk at a rate of 18% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. While this is not particularly good, its not particularly bad either.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Saudia Dairy & Foodstuff is trading on a high P/E or a low P/E, relative to its industry.
Is Saudia Dairy & Foodstuff Making Efficient Use Of Its Profits?
With a high three-year median payout ratio of 60% (implying that the company keeps only 40% of its income) of its business to reinvest into its business), most of Saudia Dairy & Foodstuff's profits are being paid to shareholders, which explains the absence of growth in earnings.
Moreover, Saudia Dairy & Foodstuff has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. 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 65%. As a result, Saudia Dairy & Foodstuff's ROE is not expected to change by much either, which we inferred from the analyst estimate of 18% for future ROE.
On the whole, we do feel that Saudia Dairy & Foodstuff has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, we studied current analyst estimates and discovered that analysts expect the company's earnings growth to improve slightly. Sure enough, this could bring some relief to shareholders. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
When trading Saudia Dairy & Foodstuff or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.