Are Almarai Company's (TADAWUL:2280) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

Almarai (TADAWUL:2280) has had a rough three months with its share price down 8.8%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Almarai's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Almarai

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 Almarai is:

12% = ر.س1.9b ÷ ر.س16b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each SAR1 of shareholders' capital it has, the company made SAR0.12 in profit.

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. 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.

Almarai's Earnings Growth And 12% ROE

At first glance, Almarai's ROE doesn't look very promising. However, its ROE is similar to the industry average of 11%, so we won't completely dismiss the company. Having said that, Almarai's net income growth over the past five years is more or less flat. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat growth in earnings.

We then compared Almarai's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 25% in the same period. This does appease the negative sentiment around the company to a certain extent.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for 2280? You can find out in our latest intrinsic value infographic research report.

Is Almarai Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 43% (or a retention ratio of 57%), Almarai hasn't seen much growth in its earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Almarai has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 45%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 14%.

Conclusion

On the whole, we feel that the performance shown by Almarai can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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