Provide IT Sweden's (NGM:PROVIT) stock is up by a considerable 19% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Provide IT Sweden's ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 Provide IT Sweden is:
22% = kr2.1m ÷ kr9.6m (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.22 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
Provide IT Sweden's Earnings Growth And 22% ROE
To begin with, Provide IT Sweden has a pretty high ROE which is interesting. Even when compared to the industry average of 24% the company's ROE is pretty decent. However, while Provide IT Sweden has a pretty respectable ROE, its five year net income decline rate was 7.3%. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
So, as a next step, we compared Provide IT Sweden'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 9.0% in the same period.
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. 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 Provide IT Sweden is trading on a high P/E or a low P/E, relative to its industry.
Is Provide IT Sweden Efficiently Re-investing Its Profits?
Provide IT Sweden's high three-year median payout ratio of 158% 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. Our risks dashboard should have the 5 risks we have identified for Provide IT Sweden.
Additionally, Provide IT Sweden has paid dividends over a period of five years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.
In total, we're a bit ambivalent about Provide IT Sweden's performance. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. Up till now, we've only made a short study of the company's growth data. To gain further insights into Provide IT Sweden's past profit growth, check out this visualization of past earnings, revenue and cash flows.
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.