Is Royal Mail plc’s (LON:RMG) Stock Price Struggling As A Result Of Its Mixed Financials?

Royal Mail (LON:RMG) has had a rough three months with its share price down 16%. It seems that the market might have completely ignored the positive aspects of the company’s fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company’s financials. In this article, we decided to focus on Royal Mail’s ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Royal Mail

How Do You 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 Royal Mail is:

13% = UK£620m ÷ UK£4.8b (Based on the trailing twelve months to March 2021).

The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each £1 of shareholders’ capital it has, the company made £0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we’ve learned that ROE is a measure of a company’s profitability. 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.

Royal Mail’s Earnings Growth And 13% ROE

At first glance, Royal Mail seems to have a decent ROE. Yet, the fact that the company’s ROE is lower than the industry average of 18% does temper our expectations. Additionally, the flat earnings seen by Royal Mail over the past five years doesn’t paint a very bright picture. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. Therefore, the flat earnings growth could be the result of other factors. These include low earnings retention or poor capital allocation.

As a next step, we compared Royal Mail’s net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 12% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is RMG fairly valued? This infographic on the company’s intrinsic value has everything you need to know.

Is Royal Mail Efficiently Re-investing Its Profits?

Royal Mail has a high three-year median payout ratio of 71% (or a retention ratio of 29%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there’s been no growth in its earnings.

Moreover, Royal Mail has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 43% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

In total, we’re a bit ambivalent about Royal Mail’s performance. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. That being so, according to the latest industry analyst forecasts, the company’s earnings are expected to shrink slightly in the future. 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.

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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