Is Sigma Healthcare Limited's (ASX:SIG) Recent Performance Underpinned By Weak Financials?
It is hard to get excited after looking at Sigma Healthcare's (ASX:SIG) recent performance, when its stock has declined 3.1% over the past week. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Sigma Healthcare
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Sigma Healthcare is:
0.6% = AU$3.0m ÷ AU$478m (Based on the trailing twelve months to January 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$0.01 in profit.
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. 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.
A Side By Side comparison of Sigma Healthcare's Earnings Growth And 0.6% ROE
It is quite clear that Sigma Healthcare's ROE is rather low. Even compared to the average industry ROE of 6.3%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 35% seen by Sigma Healthcare was possibly a 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.
That being said, we compared Sigma Healthcare's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% in the same period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Using Its Retained Earnings Effectively?
Sigma Healthcare's very high LTM (or last twelve month) payout ratio of 547% 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.
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 drop to 57% over the next three years. The fact that the company's ROE is expected to rise to 4.6% over the same period is explained by the drop in the payout ratio.
Conclusion
Overall, we would be extremely cautious before making any decision on Sigma Healthcare. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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