Yahoo Finance Declining Stock and Decent Financials: Is The Market Wrong About Shriro Holdings Limited (ASX:SHM)?
With its stock down 6.3% over the past three months, it is easy to disregard Shriro Holdings (ASX:SHM). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Shriro Holdings' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Shriro Holdings
How To 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 Shriro Holdings is:
20% = AU$14m ÷ AU$66m (Based on the trailing twelve months to June 2021).
The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.20.
What Has ROE Got To Do With 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Shriro Holdings' Earnings Growth And 20% ROE
To start with, Shriro Holdings' ROE looks acceptable. Even when compared to the industry average of 18% the company's ROE looks quite decent. However, while Shriro Holdings has a pretty respectable ROE, its five year net income decline rate was 5.5% . We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.
However, when we compared Shriro Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.
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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Shriro Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Shriro Holdings Using Its Retained Earnings Effectively?
Shriro Holdings has a high three-year median payout ratio of 83% (that is, it is retaining 17% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. 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. You can see the 3 risks we have identified for Shriro Holdings by visiting our risks dashboard for free on our platform here.
Additionally, Shriro Holdings has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.
Summary
In total, it does look like Shriro Holdings has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Up till now, we've only made a short study of the company's growth data. You can do your own research on Shriro Holdings and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
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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.
