Scales’ (NZSE:SCL) stock up by 7.6% 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. In this article, we decided to focus on Scales’ ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company’s success at turning shareholder investments into profits.
View our latest analysis for Scales
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 Scales is:
6.4% = NZ$25m ÷ NZ$385m (Based on the trailing twelve months to December 2023).
The ‘return’ is the profit over the last twelve months. One way to conceptualize this is that for each NZ$1 of shareholders’ capital it has, the company made NZ$0.06 in profit.
Why Is ROE Important For Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. 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.
Scales’ Earnings Growth And 6.4% ROE
When you first look at it, Scales’ ROE doesn’t look that attractive. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 12% either. Therefore, it might not be wrong to say that the five year net income decline of 30% seen by Scales was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as – low earnings retention or poor allocation of capital.
As a next step, we compared Scales’ performance with the industry and found thatScales’ performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 3.7% in the same period, which is a slower than the company.
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. Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about Scales”s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Scales Making Efficient Use Of Its Profits?
Scales’ very high three-year median payout ratio of 115% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company’s shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. To know the 2 risks we have identified for Scales visit our risks dashboard for free.
Moreover, Scales has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 66% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 10%, over the same period.
Conclusion
Overall, we would be extremely cautious before making any decision on Scales. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
