With its stock down 5.2% over the past week, it is easy to disregard Rand Merchant Investment Holdings (JSE:RMI). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Rand Merchant Investment Holdings' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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 Rand Merchant Investment Holdings is:
7.7% = R2.7b ÷ R35b (Based on the trailing twelve months to December 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.08 in profit.
Why Is ROE Important For 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.
Rand Merchant Investment Holdings' Earnings Growth And 7.7% ROE
It is quite clear that Rand Merchant Investment Holdings' ROE is rather low. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. For this reason, Rand Merchant Investment Holdings' five year net income decline of 12% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
From the 12% decline reported by the industry in the same period, we infer that Rand Merchant Investment Holdings and its industry are both shrinking at a similar rate.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is Rand Merchant Investment Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Rand Merchant Investment Holdings Using Its Retained Earnings Effectively?
Looking at its three-year median payout ratio of 43% (or a retention ratio of 57%) which is pretty normal, Rand Merchant Investment Holdings' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. 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, Rand Merchant Investment Holdings 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 78% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
Overall, we have mixed feelings about Rand Merchant Investment Holdings. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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.