Saudi Company for Hardware's (TADAWUL:4008) stock is up by a considerable 16% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. In this article, we decided to focus on Saudi Company for Hardware's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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 Saudi Company for Hardware is:
15% = ر.س89m ÷ ر.س599m (Based on the trailing twelve months to March 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every SAR1 worth of equity, the company was able to earn SAR0.15 in profit.
What Has ROE Got To Do With 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. 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.
A Side By Side comparison of Saudi Company for Hardware's Earnings Growth And 15% ROE
On the face of it, Saudi Company for Hardware's ROE is not much to talk about. However, its ROE is similar to the industry average of 15%, so we won't completely dismiss the company. Having said that, Saudi Company for Hardware's five year net income decline rate was 13%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.
However, when we compared Saudi Company for Hardware's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.5% in the same period. This is quite worrisome.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Saudi Company for Hardware is trading on a high P/E or a low P/E, relative to its industry.
Is Saudi Company for Hardware Using Its Retained Earnings Effectively?
Saudi Company for Hardware'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 60% (or a retention ratio of 40%). With only very little left to reinvest into the business, growth in earnings is far from likely.
In addition, Saudi Company for Hardware 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 62%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 16%.
Overall, we would be extremely cautious before making any decision on Saudi Company for Hardware. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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