Santam (JSE:SNT) has had a rough month with its share price down 7.3%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Specifically, we decided to study Santam's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Santam is:
6.4% = R646m ÷ R10b (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 ZAR1 worth of equity, the company was able to earn ZAR0.06 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.
A Side By Side comparison of Santam's Earnings Growth And 6.4% ROE
It is quite clear that Santam's ROE is rather low. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. For this reason, Santam's five year net income decline of 5.0% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
Next, on comparing with the industry net income growth, we found that Santam's earnings seems to be shrinking at a similar rate as the industry which shrunk at a rate of a rate of 4.5% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Santam's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Santam Efficiently Re-investing Its Profits?
While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.
Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 55% of its profits over the next three years. However, Santam's ROE is predicted to rise to 24% despite there being no anticipated change in its payout ratio.
In total, we would have a hard think before deciding on any investment action concerning Santam. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. 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.
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