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It is hard to get excited after looking at United Malt Group's (ASX:UMG) recent performance, when its stock has declined 14% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on United Malt Group's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 United Malt Group is:
1.0% = AU$11m ÷ AU$1.0b (Based on the trailing twelve months to March 2022).
The 'return' is the profit 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$0.01 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of United Malt Group's Earnings Growth And 1.0% ROE
It is hard to argue that United Malt Group's ROE is much good in and of itself. Not just that, even compared to the industry average of 9.3%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 35% seen by United Malt Group was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared United Malt Group'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 13% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is United Malt Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is United Malt Group Using Its Retained Earnings Effectively?
United Malt Group has a high three-year median payout ratio of 82% (that is, it is retaining 18% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for United Malt Group visit our risks dashboard for free.
Only recently, United Malt Group stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 60% over the next three years. As a result, the expected drop in United Malt Group's payout ratio explains the anticipated rise in the company's future ROE to 7.6%, over the same period.
Overall, we would be extremely cautious before making any decision on United Malt Group. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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.
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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