Should Weakness in Saudia Dairy & Foodstuff Company's (TADAWUL:2270) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Saudia Dairy & Foodstuff (TADAWUL:2270) has had a rough three months with its share price down 7.0%. 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 Saudia Dairy & Foodstuff'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Saudia Dairy & Foodstuff

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Saudia Dairy & Foodstuff is:

18% = ر.س283m ÷ ر.س1.5b (Based on the trailing twelve months to September 2020).

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 SAR0.18 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Saudia Dairy & Foodstuff's Earnings Growth And 18% ROE

To begin with, Saudia Dairy & Foodstuff seems to have a respectable ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Given the circumstances, we can't help but wonder why Saudia Dairy & Foodstuff saw little to no growth in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

Next, we compared Saudia Dairy & Foodstuff's performance against the industry and found that the industry shrunk its earnings at 26% in the same period, which suggests that the company's earnings have been shrinking at a slower rate than its industry, This does appease the negative sentiment around the company to a certain extent.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 59% (implying that the company keeps only 41% 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.

In addition, Saudia Dairy & Foodstuff has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 66%. However, Saudia Dairy & Foodstuff's ROE is predicted to rise to 27% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we do feel that Saudia Dairy & Foodstuff 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. 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. 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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