Does The Market Have A Low Tolerance For Saudi Ground Services Company's (TADAWUL:4031) Mixed Fundamentals?

It is hard to get excited after looking at Saudi Ground Services' (TADAWUL:4031) recent performance, when its stock has declined 9.0% over the past month. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Saudi Ground Services' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Saudi Ground Services

How Is ROE Calculated?

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 Ground Services is:

11% = ر.س271m ÷ ر.س2.5b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every SAR1 worth of shareholders' equity, the company generated SAR0.11 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. 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.

A Side By Side comparison of Saudi Ground Services' Earnings Growth And 11% ROE

As you can see, Saudi Ground Services' ROE looks pretty weak. However, the fact that it is higher than the industry average of 8.3% makes us a bit more interested. Or may be not, given Saudi Ground Services' five year net income decline of 7.8% in the past five years. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that's what might be causing earnings growth to shrink.

That being said, we compared Saudi Ground Services' 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 8.2% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Ground Services''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Saudi Ground Services Efficiently Re-investing Its Profits?

Saudi Ground Services' 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 69% (or a retention ratio of 31%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Moreover, Saudi Ground Services has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 74%. Still, forecasts suggest that Saudi Ground Services' future ROE will rise to 16% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we have mixed feelings about Saudi Ground Services. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. 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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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.