Does The Market Have A Low Tolerance For SJR in Scandinavia AB (publ)'s (STO:SJR B) Mixed Fundamentals?

It is hard to get excited after looking at SJR in Scandinavia's (STO:SJR B) recent performance, when its stock has declined 5.8% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on SJR in Scandinavia's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 SJR in Scandinavia

How Is ROE Calculated?

Return on equity 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 SJR in Scandinavia is:

20% = kr12m ÷ kr63m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.20.

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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

SJR in Scandinavia's Earnings Growth And 20% ROE

To start with, SJR in Scandinavia's ROE looks acceptable. On comparing with the average industry ROE of 8.2% the company's ROE looks pretty remarkable. For this reason, SJR in Scandinavia's five year net income decline of 10% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared SJR in Scandinavia's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 1.2% in the same period.

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. 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 SJR in Scandinavia is trading on a high P/E or a low P/E, relative to its industry.

Is SJR in Scandinavia Using Its Retained Earnings Effectively?

SJR in Scandinavia's high three-year median payout ratio of 106% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. To know the 2 risks we have identified for SJR in Scandinavia visit our risks dashboard for free.

Additionally, SJR in Scandinavia has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 81% over the next three years. The fact that the company's ROE is expected to rise to 27% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we have mixed feelings about SJR in Scandinavia. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings 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. 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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