Sanlam (JSE: SLM) stock is up 4.1% in the past three months. Given that markets typically pay for a company’s long-term financial health, we wonder if the current stock price momentum will hold up, given that the company’s financial data doesn’t look very promising. . In this article, we have decided to focus on Sanlam’s ROE.

Return on equity or ROE is an important factor for a shareholder to consider because it tells them how efficiently their capital is being reinvested. Simply put, it is used to assess a company’s profitability against its equity.

See our latest analysis for Sanlam

How do you calculate return on equity?

Return on equity can be calculated using the formula:

Return on equity = Net income (from continuing operations) Equity

So, based on the above formula, the ROE for Sanlam is:

4.7% = R3.6b ÷ R77b (Based on the last twelve months up to December 2020).

The “return” is the annual profit. Another way to think about this is that for every ZAR1 value of equity, the company was able to make a profit of ZAR 0.05.

What is the relationship between ROE and profit growth?

So far, we’ve learned that ROE measures how efficiently a business generates profits. Based on how much of those profits the company reinvests or “withholds” and how efficiently it does so, we are then able to assess a company’s profit growth potential. Assuming everything is equal, companies that have both a higher return on equity and higher profit retention are generally those that have a higher growth rate than companies that do not have the same characteristics. .

A side-by-side comparison of Sanlam’s profit growth and 4.7% ROE

It is difficult to say that the ROE of Sanlam is very good on its own. Not only that, even compared to the industry average of 10%, the company’s ROE is quite unremarkable. Therefore, it may not be wrong to say that the 17% drop in five-year net profit seen by Sanlam may have been the result of lower ROE. We believe there could also be other aspects that negatively influence the company’s earnings outlook. For example, the company has a very high payout rate or faces competitive pressures.

In the next step, we compared the performance of Sanlam with the industry and found that the performance of Sanlam is depressing even compared to the industry, which reduced its profits at a rate of 5.5% during of the same period, which is slower than the business.

The basis for attaching value to a business is, to a large extent, related to the growth of its profits. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. This will help him determine if the future of the stock looks bright or worrisome. A good indicator of expected earnings growth is the P / E ratio which determines the price the market is willing to pay for a stock based on its earnings outlook. So, you might want to check whether Sanlam is trading high P / E or low P / E, relative to its industry.

Is Sanlam Using Profits Effectively?

Sanlam’s decline in profits is not surprising given that the company spends most of its profits on paying dividends, judging by its three-year median payout rate of 64% (or a retention rate of 36 %). With very little to reinvest in the business, earnings growth is far from likely. Our risk dashboard should contain the 3 risks we have identified for Sanlam.

Additionally, Sanlam has paid dividends over a period of at least ten years, suggesting that sustaining dividend payments is much more important to management, even if it comes at the expense of growing the business. . 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 69%. However, Sanlam’s ROE is expected to increase to 18% although there is no expected change in its payout ratio.

summary

All in all, we would have thought carefully before deciding on any investment action regarding Sanlam. Due to its low ROE and lack of reinvestment in the business, the company recorded a disappointing rate of profit growth. That said, looking at current analysts’ estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. Are the expectations of these analysts based on general industry expectations or on company fundamentals? Click here to go to our business analyst forecasts page.

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