Can Al-Yamamah Steel Industries Company's (TADAWUL:1304) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Most readers would already be aware that Al-Yamamah Steel Industries' (TADAWUL:1304) stock increased significantly by 47% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study Al-Yamamah Steel Industries' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Al-Yamamah Steel Industries

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 Al-Yamamah Steel Industries is:

16% = ر.س136m ÷ ر.س833m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. So, this means that for every SAR1 of its shareholder's investments, the company generates a profit of SAR0.16.

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. 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.

Al-Yamamah Steel Industries' Earnings Growth And 16% ROE

On the face of it, Al-Yamamah Steel Industries' ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 6.6% doesn't go unnoticed by us. But seeing Al-Yamamah Steel Industries' five year net income decline of 47% over the past five years, we might rethink that. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the decline in earnings could also be the result of this.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 36% in the same period, we still found Al-Yamamah Steel Industries' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

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. 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 Al-Yamamah Steel Industries is trading on a high P/E or a low P/E, relative to its industry.

Is Al-Yamamah Steel Industries Making Efficient Use Of Its Profits?

Al-Yamamah Steel Industries' 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 100% (or a retention ratio of -0.3%). 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 Al-Yamamah Steel Industries visit our risks dashboard for free.

In addition, Al-Yamamah Steel Industries has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Al-Yamamah Steel Industries. While its ROE is pretty moderate, the company is retaining very little of its profits, meaning very little of its profits are being reinvested into the business. This explains the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Al-Yamamah Steel Industries' 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. 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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