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Stockland's (ASX:SGP) stock is up by a considerable 6.2% over the past month. 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. Particularly, we will be paying attention to Stockland's ROE today.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To 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 Stockland is:
12% = AU$1.1b ÷ AU$9.6b (Based on the trailing twelve months to June 2021).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.12 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. 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.
Stockland's Earnings Growth And 12% ROE
To start with, Stockland's ROE looks acceptable. Especially when compared to the industry average of 9.5% the company's ROE looks pretty impressive. For this reason, Stockland's five year net income decline of 27% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared Stockland's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.1% in the same period. This is quite worrisome.
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. 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 SGP? You can find out in our latest intrinsic value infographic research report.
Is Stockland Making Efficient Use Of Its Profits?
Stockland seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 68% (meaning, the company retains only 32% of profits). However, this is typical for REITs as they are often required by law to distribute most of their earnings. Accordingly, this likely explains why its earnings have been shrinking.
Additionally, Stockland 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 is expected to keep paying out approximately 77% of its profits over the next three years. Still, forecasts suggest that Stockland's future ROE will drop to 7.8% even though the the company's payout ratio is not expected to change by much.
In total, it does look like Stockland has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. That being so, the latest industry analyst forecasts show that analysts are forecasting a slight improvement in the company's future earnings growth. This could offer some relief to the company's existing shareholders. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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