Could the market be wrong about OEM International AB (publ) (STO:OEM B) given its attractive financial outlook?
OEM International (STO:OEM B) had a difficult month with a 25% decline in its share price. However, a closer look at his healthy finances might make you think again. Since fundamentals generally determine long-term market outcomes, the company is worth looking into. In this article, we have decided to focus on the ROE of OEM International.
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
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How to 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 OEM International is:
41% = 531 million kr ÷ 1.3 billion kr (based on the last twelve months until June 2022).
The “yield” is the profit of the last twelve months. One way to conceptualize this is that for every SEK1 of share capital it has, the company has made a profit of SEK 0.41.
Why is ROE important for earnings growth?
We have already established that ROE serves as an effective profit-generating indicator for a company’s future earnings. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
OEM International earnings growth and ROE of 41%
First, we appreciate that OEM International has an impressive ROE. Second, a comparison with the average industry-reported ROE of 20% also does not go unnoticed for us. Probably because of this, OEM International has been able to see a decent 18% net income growth over the past five years.
As a next step, we compared OEM International’s net income growth with the industry and found that the company had a similar growth figure compared to the industry average growth rate of 17% over the past of the same period.
The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. This then helps them determine if the stock is positioned for a bright or bleak future. 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. Thus, you might want to check whether OEM International is trading on a high P/E or a low P/E, relative to its industry.
Does OEM International effectively reinvest its profits?
OEM International has a healthy combination of a moderate three-year median payout ratio of 45% (or a retention rate of 55%) and respectable earnings growth, as we saw above, this which means that the company has made efficient use of its profits.
Additionally, OEM International has paid dividends over a period of at least ten years, which means the company is pretty serious about sharing its profits with its shareholders.
All in all, we are quite satisfied with OEM International’s performance. In particular, we appreciate the fact that the company is reinvesting heavily in its business, and at a high rate of return. Unsurprisingly, this led to impressive earnings growth. If the company continues to increase earnings as it has, it could have a positive impact on its share price given how earnings per share influence prices over the long term. Not to mention that stock price results also depend on the potential risks that a company may face. It is therefore important for investors to be aware of the risks associated with the business. You can see the 2 risks we have identified for OEM International by visiting our risk dashboard for free on our platform here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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