Provide IT Sweden AB (publ)'s (NGM:PROVIT) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Coorect Its Share Price?

Most readers would already be aware that Provide IT Sweden's (NGM:PROVIT) stock increased significantly by 20% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study Provide IT Sweden'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Provide IT Sweden

How Do You Calculate Return On Equity?

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 Provide IT Sweden is:

11% = kr1.8m ÷ kr17m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of Provide IT Sweden's Earnings Growth And 11% ROE

At first glance, Provide IT Sweden seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 14% does temper our expectations. Further research shows that Provide IT Sweden's net income has shrunk at a rate of 32% over the last five years. Bear in mind, the company does have a high ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings to shrink. 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 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 11% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Provide IT Sweden's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Provide IT Sweden Making Efficient Use Of Its Profits?

With a three-year median payout ratio as high as 177%,Provide IT Sweden's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. 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 three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

Overall, we would be extremely cautious before making any decision on Provide IT Sweden. While its ROE is pretty moderate, the company is retaining very little of its profits, meaning very little of its profits are being reinvested into the business. This explains the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Provide IT Sweden's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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