Yahoo Finance Orora Limited's (ASX:ORA) Financial Prospects Don't Look Very Positive: Could It Mean A Stock Price Drop In The Future?
Most readers would already know that Orora's (ASX:ORA) stock increased by 7.9% over the past three months. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Specifically, we decided to study Orora's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Orora
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Orora is:
3.9% = AU$36m ÷ AU$915m (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.04 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Orora's Earnings Growth And 3.9% ROE
It is hard to argue that Orora's ROE is much good in and of itself. Not just that, even compared to the industry average of 9.6%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 17% seen by Orora over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
However, when we compared Orora's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.6% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for ORA? You can find out in our latest intrinsic value infographic research report.
Is Orora Using Its Retained Earnings Effectively?
Orora's high three-year median payout ratio of 114% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. To know the 4 risks we have identified for Orora visit our risks dashboard for free.
In addition, Orora has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 80% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 20%, over the same period.
Summary
In total, we would have a hard think before deciding on any investment action concerning Orora. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. 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. 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. 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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