Declining Stock and Decent Financials: Is The Market Wrong About Saudi Automotive Services Company (TADAWUL:4050)?

Saudi Automotive Services (TADAWUL:4050) has had a rough month with its share price down 3.9%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Saudi Automotive Services' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Saudi Automotive Services

How To 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 Saudi Automotive Services is:

15% = ر.س125m ÷ ر.س822m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. 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 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Saudi Automotive Services' Earnings Growth And 15% ROE

When you first look at it, Saudi Automotive Services' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 15%. Moreover, we are quite pleased to see that Saudi Automotive Services' net income grew significantly at a rate of 36% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Saudi Automotive Services' growth is quite high when compared to the industry average growth of 6.9% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Saudi Automotive Services''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Saudi Automotive Services Making Efficient Use Of Its Profits?

Saudi Automotive Services' significant three-year median payout ratio of 74% (where it is retaining only 26% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Besides, Saudi Automotive Services has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 46% over the next three years. Regardless, the future ROE for Saudi Automotive Services is predicted to decline to 11% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Summary

Overall, we feel that Saudi Automotive Services certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. 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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