Santam Ltd's (JSE:SNT) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?

By
Simply Wall St
Published
November 18, 2021
JSE:SNT
Source: Shutterstock

Santam's (JSE:SNT) stock up by 6.2% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Santam's ROE.

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.

See our latest analysis for Santam

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Santam is:

15% = R1.6b ÷ R11b (Based on the trailing twelve months to June 2021).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.15.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Santam's Earnings Growth And 15% ROE

On the face of it, Santam's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 9.0% doesn't go unnoticed by us. But seeing Santam's five year net income decline of 4.7% over the past five years, we might rethink that. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the shrinking earnings.

We then compared Santam's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 11% in the same period. This does offer shareholders some relief

past-earnings-growth
JSE:SNT Past Earnings Growth November 19th 2021

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Santam is trading on a high P/E or a low P/E, relative to its industry.

Is Santam Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 49% (that is, a retention ratio of 51%), the fact that Santam's earnings have shrunk is quite puzzling. 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, Santam 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 over the next three years is expected to be approximately 58%. Still, forecasts suggest that Santam's future ROE will rise to 25% even though the the company's payout ratio is not expected to change by much.

Summary

In total, it does look like Santam has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. 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. 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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