Svenska Cellulosa Aktiebolaget SCA (publ)'s (STO:SCA B) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Svenska Cellulosa Aktiebolaget (STO:SCA B) has had a great run on the share market with its stock up by a significant 18% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Svenska Cellulosa Aktiebolaget's 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.

Check out our latest analysis for Svenska Cellulosa Aktiebolaget

How Do You 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 Svenska Cellulosa Aktiebolaget is:

3.1% = kr3.2b ÷ kr103b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.03 in profit.

Why Is ROE Important For 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 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.

Svenska Cellulosa Aktiebolaget's Earnings Growth And 3.1% ROE

When you first look at it, Svenska Cellulosa Aktiebolaget's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.9%. For this reason, Svenska Cellulosa Aktiebolaget's five year net income decline of 12% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

However, when we compared Svenska Cellulosa Aktiebolaget's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 15% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Svenska Cellulosa Aktiebolaget is trading on a high P/E or a low P/E, relative to its industry.

Is Svenska Cellulosa Aktiebolaget Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 29% (where it is retaining 71% of its profits), Svenska Cellulosa Aktiebolaget has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Svenska Cellulosa Aktiebolaget has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 44% over the next three years. Still, forecasts suggest that Svenska Cellulosa Aktiebolaget's future ROE will rise to 5.2% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

Overall, we have mixed feelings about Svenska Cellulosa Aktiebolaget. While the company does have a high rate of profit retention, its low rate of return is probably 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. 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.