RCL Foods (JSE: RCL) has had an excellent performance in the equity market with a significant increase in its shares of 18% in the past three months. However, we wonder if the inconsistent financial data of the company would negatively impact the current momentum in stock prices. Specifically, we have decided to study the ROE of RCL Foods in this article.
Return on equity or ROE is an important factor for a shareholder to consider, as it tells them how efficiently their capital is being reinvested. In short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
See our latest review for RCL Foods
How to calculate return on equity?
the return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, based on the above formula, the ROE of RCL Foods is:
9.3% = R996m ÷ R11b (Based on the last twelve months up to July 2021).
The “return” is the amount earned after tax over the past twelve months. Another way to look at this is that for every ZAR1 value of equity, the company was able to earn ZAR0.09 in profit.
What is the relationship between ROE and profit growth?
We have already established that ROE is an effective indicator of profit generation for a company’s future profits. Based on the portion of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Generally speaking, all other things being equal, companies with high return on equity and high profit retention have a higher growth rate than companies that do not share these attributes.
RCL Foods and RCP profit growth of 9.3%
It is quite clear that RCL Foods’ ROE is rather low. An industry comparison shows that the company’s ROE is also not significantly different from the industry average of 11%. Therefore, it may not be wrong to say that the 27% drop in five-year net income seen by RCL Foods may have been the result of disappointing ROE.
Moreover, even compared to the industry, which cut its profits at a rate of 4.4% over the same period, we found RCL Foods’ performance to be quite disappointing, as it suggests that the company has cut its profits at a faster rate than the industry.
Profit growth is a huge factor in the valuation of stocks. What investors next need to determine is whether the expected earnings growth, or lack thereof, is already built into the share price. This will help them determine whether the future of the stock looks bright or threatening. Has the market assessed RCL’s future prospects? You can find out in our latest Intrinsic Value infographic research report.
Is RCL Foods Using Retained Earnings Effectively?
Looking at its 40% LTM (or past twelve months) payout ratio (or 60% retention rate), which is pretty normal, RCL Foods’ decline in earnings is rather disconcerting as one would expect. see good growth when a company retains a good portion of its profits. It seems that there could be other reasons for the lack in this regard. For example, the business could be in decline.
In addition, RCL Foods has paid dividends over a period of at least ten years, which means that the management of the company is committed to paying dividends even if it means little or no growth in earnings. Based on the latest analyst estimates, we found that the company’s future payout ratio over the next three years is expected to hold steady at 37%. Therefore, the company’s future ROE is also unlikely to change much, with analysts predicting an ROE of 11%.
Overall, we believe that the performance shown by RCL Foods can be open to many interpretations. Although the company has a high reinvestment rate, the low ROE means that all that reinvestment is not benefiting its investors and, moreover, it has a negative impact on profit growth. That said, we have studied the latest analysts’ forecast and found that while the company has cut profits in the past, analysts expect its profits to rise in the future. To learn more about the latest analyst forecast for the business, check out this visualization of the analyst forecast for the business.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.