It is hard to get excited after looking at Zahrat Al Waha For Trading's (TADAWUL:3007) recent performance, when its stock has declined 1.4% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Zahrat Al Waha For Trading's ROE today.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Zahrat Al Waha For Trading is:
18% = ر.س48m ÷ ر.س273m (Based on the trailing twelve months to March 2021).
The 'return' is the yearly profit. So, this means that for every SAR1 of its shareholder's investments, the company generates a profit of SAR0.18.
What Is The Relationship Between ROE And 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 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.
Zahrat Al Waha For Trading's Earnings Growth And 18% ROE
To start with, Zahrat Al Waha For Trading's ROE looks acceptable. Especially when compared to the industry average of 8.8% the company's ROE looks pretty impressive. However, for some reason, the higher returns aren't reflected in Zahrat Al Waha For Trading's meagre five year net income growth average of 4.8%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing Zahrat Al Waha For Trading's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 5.6% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Zahrat Al Waha For Trading is trading on a high P/E or a low P/E, relative to its industry.
Is Zahrat Al Waha For Trading Efficiently Re-investing Its Profits?
While Zahrat Al Waha For Trading has a decent three-year median payout ratio of 38% (or a retention ratio of 62%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Moreover, Zahrat Al Waha For Trading has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
In total, we are pretty happy with Zahrat Al Waha For Trading's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 1 risk we have identified for Zahrat Al Waha For Trading visit our risks dashboard for free.
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