Does Tanmiah Food Company's (TADAWUL:2281) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Tanmiah Food's (TADAWUL:2281) stock is up by a considerable 22% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Tanmiah Food'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.

See our latest analysis for Tanmiah Food

How Do You Calculate Return On Equity?

ROE 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 Tanmiah Food is:

12% = ر.س80m ÷ ر.س651m (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. That means that for every SAR1 worth of shareholders' equity, the company generated SAR0.12 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Tanmiah Food's Earnings Growth And 12% ROE

As you can see, Tanmiah Food's ROE looks pretty weak. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 12%. Therefore, it might not be wrong to say that the five year net income decline of 4.2% seen by Tanmiah Food was possibly a result of the disappointing ROE.

So, as a next step, we compared Tanmiah Food's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 12% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Tanmiah Food fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Tanmiah Food Efficiently Re-investing Its Profits?

Tanmiah Food's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 75% (or a retention ratio of 25%). With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, Tanmiah Food only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 13% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we would be extremely cautious before making any decision on Tanmiah Food. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.