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Sunland Group Limited's (ASX:SDG) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

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With its stock down 2.5% over the past three months, it is easy to disregard Sunland Group (ASX:SDG). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Sunland Group’s ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Sunland Group

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity

So, based on the above formula, the ROE for Sunland Group is:

14% = AU$43m ÷ AU$307m (Based on the trailing twelve months to December 2021).

The ‘return’ is the amount earned after tax 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$0.14 in profit.

Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Sunland Group’s Earnings Growth And 14% ROE

To begin with, Sunland Group seems to have a respectable ROE. Especially when compared to the industry average of 7.4% the company’s ROE looks pretty impressive. Needless to say, we are quite surprised to see that Sunland Group’s net income shrunk at a rate of 17% over the past five years. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

As a next step, we compared Sunland Group’s performance with the industry and found thatSunland Group’s performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 10% in the same period, which is a slower than the company.

past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you’re wondering about Sunland Group’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sunland Group Using Its Retained Earnings Effectively?

Sunland Group’s declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 67% (or a retention ratio of 33%). With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Sunland Group.

Moreover, Sunland Group has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 40% over the next three years. The fact that the company’s ROE is expected to rise to 18% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we feel that Sunland Group certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren’t reaping the benefits of the high rate of return. So far, we’ve only made a quick discussion around the company’s earnings growth. So it may be worth checking this free detailed graph of Sunland Group’s past earnings, as well as revenue and cash flows to get a deeper insight into the company’s performance.

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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.