Arabian Food and Dairy Factories Company's (TADAWUL:9536) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Arabian Food and Dairy Factories (TADAWUL:9536) has had a great run on the share market with its stock up by a significant 24% over the last month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Arabian Food and Dairy Factories' 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.

Check out our latest analysis for Arabian Food and Dairy Factories

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 Food and Dairy Factories is:

20% = ر.س6.9m ÷ ر.س35m (Based on the trailing twelve months to June 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 SAR0.20 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Food and Dairy Factories' Earnings Growth And 20% ROE

When you first look at it, Arabian Food and Dairy Factories' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 18%. Having said that, Arabian Food and Dairy Factories' five year net income decline rate was 9.4%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared Arabian Food and Dairy Factories' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 16% in the same 5-year period.

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 9536? You can find out in our latest intrinsic value infographic research report

Is Arabian Food and Dairy Factories Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 57% (implying that 43% of the profits are retained), most of Arabian Food and Dairy Factories' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 4 risks we have identified for Arabian Food and Dairy Factories visit our risks dashboard for free.

Additionally, Arabian Food and Dairy Factories started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Summary

In total, we would have a hard think before deciding on any investment action concerning Arabian Food and Dairy Factories. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Up till now, we've only made a short study of the company's growth data. To gain further insights into Arabian Food and Dairy Factories' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.