Can Mixed Fundamentals Have A Negative Impact on Sigma Healthcare Limited (ASX:SIG) Current Share Price Momentum?
Sigma Healthcare's (ASX:SIG) stock is up by a considerable 50% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Sigma Healthcare's ROE today.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Sigma Healthcare
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 Sigma Healthcare is:
3.2% = AU$16m ÷ AU$485m (Based on the trailing twelve months to July 2023).
The 'return' is the profit 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$0.03 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Sigma Healthcare's Earnings Growth And 3.2% ROE
It is quite clear that Sigma Healthcare's ROE is rather low. Even compared to the average industry ROE of 6.7%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 25% seen by Sigma Healthcare was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
So, as a next step, we compared Sigma Healthcare'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 1.3% over the last few years.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is SIG worth today? The intrinsic value infographic in our free research report helps visualize whether SIG is currently mispriced by the market.
Is Sigma Healthcare Making Efficient Use Of Its Profits?
Sigma Healthcare's low three-year median payout ratio of 23% (or a retention ratio of 77%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.
Additionally, Sigma Healthcare 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 57% over the next three years. Regardless, the future ROE for Sigma Healthcare is speculated to rise to 6.7% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
Conclusion
Overall, we have mixed feelings about Sigma Healthcare. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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.
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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.
