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Bega Cheese Limited's (ASX:BGA) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Most readers would already be aware that Bega Cheese's (ASX:BGA) stock increased significantly by 18% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Particularly, we will be paying attention to Bega Cheese's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Bega Cheese

How Is ROE Calculated?

ROE can be calculated by using the formula:

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

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So, based on the above formula, the ROE for Bega Cheese is:

1.9% = AU$24m ÷ AU$1.3b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.02 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Bega Cheese's Earnings Growth And 1.9% ROE

As you can see, Bega Cheese's ROE looks pretty weak. Even compared to the average industry ROE of 7.8%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 19% seen by Bega Cheese over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Bega Cheese'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 7.6% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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 BGA? You can find out in our latest intrinsic value infographic research report.

Is Bega Cheese Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 78% (implying that 22% of the profits are retained), most of Bega Cheese's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 3 risks we have identified for Bega Cheese visit our risks dashboard for free.

Additionally, Bega Cheese has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 59% over the next three years. As a result, the expected drop in Bega Cheese's payout ratio explains the anticipated rise in the company's future ROE to 5.8%, over the same period.

Conclusion

Overall, we would be extremely cautious before making any decision on Bega Cheese. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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