Could Overseas Education Limited's (SGX:RQ1) Weak Financials Mean That The Market Could Correct Its Share Price?

Most readers would already know that Overseas Education's (SGX:RQ1) stock increased by 7.1% over the past three months. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Particularly, we will be paying attention to Overseas Education'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Overseas Education

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Overseas Education is:

6.8% = S$9.9m ÷ S$145m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every SGD1 worth of shareholders' equity, the company generated SGD0.07 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Overseas Education's Earnings Growth And 6.8% ROE

On the face of it, Overseas Education's ROE is not much to talk about. Next, when compared to the average industry ROE of 10%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 16% seen by Overseas Education over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared Overseas Education's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 13% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. Is Overseas Education fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Overseas Education Using Its Retained Earnings Effectively?

With a three-year median payout ratio as high as 162%,Overseas Education'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. To know the 4 risks we have identified for Overseas Education visit our risks dashboard for free.

In addition, Overseas Education has been paying dividends over a period of eight years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 140%. As a result, Overseas Education's ROE is not expected to change by much either, which we inferred from the analyst estimate of 6.2% for future ROE.

Summary

On the whole, Overseas Education's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. With that said, we studied current analyst estimates and discovered that analysts expect the company's earnings growth to improve slightly. This could offer some relief to the company's existing shareholders. 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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