Does Björn Borg AB (publ)'s (STO:BORG) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

Björn Borg's (STO:BORG) stock is up by 8.5% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Specifically, we decided to study Björn Borg's ROE in this article.

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.

View our latest analysis for Björn Borg

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Björn Borg is:

6.5% = kr19m ÷ kr291m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every SEK1 worth of equity, the company was able to earn SEK0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Björn Borg's Earnings Growth And 6.5% ROE

On the face of it, Björn Borg's ROE is not much to talk about. However, its ROE is similar to the industry average of 6.5%, so we won't completely dismiss the company. But then again, Björn Borg's five year net income shrunk at a rate of 5.9%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 4.4% in the same period, we found that Björn Borg's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

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. If you're wondering about Björn Borg's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Björn Borg Using Its Retained Earnings Effectively?

Björn Borg'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 89% (or a retention ratio of 11%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 3 risks we have identified for Björn Borg by visiting our risks dashboard for free on our platform here.

Moreover, Björn Borg has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 55% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 20%, over the same period.

Summary

On the whole, Björn Borg's performance is quite a big let-down. As a result of its low ROE and lack of mich 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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