ESR-REIT's (SGX:J91U) Financial Prospects Don't Look Very Positive: Could It Mean A Stock Price Drop In The Future?

ESR-REIT's (SGX:J91U) stock up by 6.8% over the past three months. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Specifically, we decided to study ESR-REIT's ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for ESR-REIT

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 ESR-REIT is:

0.8% = S$13m ÷ S$1.6b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.01 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 ESR-REIT's Earnings Growth And 0.8% ROE

It is quite clear that ESR-REIT's ROE is rather low. Even compared to the average industry ROE of 5.5%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 54% seen by ESR-REIT was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared ESR-REIT'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 13% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for J91U? You can find out in our latest intrinsic value infographic research report.

Is ESR-REIT Efficiently Re-investing Its Profits?

ESR-REIT seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 69% (meaning, the company retains only 31% of profits). However, this is typical for REITs as they are often required by law to distribute most of their earnings. So this probably explains the company's shrinking earnings.

In addition, ESR-REIT 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 76%. Still, forecasts suggest that ESR-REIT's future ROE will rise to 8.2% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we would have a hard think before deciding on any investment action concerning ESR-REIT. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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