Does The Market Have A Low Tolerance For Kelsian Group Limited's (ASX:KLS) Mixed Fundamentals?

editorial-team@simplywallst.com (Simply Wall St)

Sun, Sep 22, 2024, 6:01 PM 4 min read

It is hard to get excited after looking at Kelsian Group's (ASX:KLS) recent performance, when its stock has declined 19% over the past month. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Kelsian Group's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Kelsian 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 Kelsian Group is:

6.3% = AU$58m ÷ AU$927m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.06 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. 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.

A Side By Side comparison of Kelsian Group's Earnings Growth And 6.3% ROE

When you first look at it, Kelsian Group's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.8%. However, we we're pleasantly surprised to see that Kelsian Group grew its net income at a significant rate of 27% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Kelsian Group's growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

past-earnings-growth — ASX:KLS Past Earnings Growth September 23rd 2024

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is KLS fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Kelsian Group Making Efficient Use Of Its Profits?

Kelsian Group's very high three-year median payout ratio of 104% suggests that the company is paying more to its shareholders than what it is earning. Despite this, the company's earnings grew significantly as we saw above. Although, it could be worth keeping an eye on the high payout ratio as that's a huge risk. Our risks dashboard should have the 2 risks we have identified for Kelsian Group.

Besides, Kelsian Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 75% over the next three years. The fact that the company's ROE is expected to rise to 8.9% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we feel that the performance shown by Kelsian Group can be open to many interpretations. While no doubt its earnings growth is pretty substantial, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, especially during troubled times. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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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.