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Scentre Group's (ASX:SCG) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

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Most readers would already be aware that Scentre Group's (ASX:SCG) stock increased significantly by 21% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Scentre Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Scentre Group

How Is ROE Calculated?

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 Scentre Group is:

1.6% = AU$297m ÷ AU$19b (Based on the trailing twelve months to June 2021).

The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.02 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Scentre Group's Earnings Growth And 1.6% ROE

As you can see, Scentre Group's ROE looks pretty weak. Even compared to the average industry ROE of 13%, the company's ROE is quite dismal. For this reason, Scentre Group's five year net income decline of 49% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

As a next step, we compared Scentre Group's performance with the industry and found thatScentre Group's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.3% in the same period, which is a slower than the company.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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. What is SCG worth today? The intrinsic value infographic in our free research report helps visualize whether SCG is currently mispriced by the market.

Is Scentre Group Using Its Retained Earnings Effectively?

Scentre Group seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 88% (meaning, the company retains only 12% of profits). However, this is typical for REITs as they are often required by law to distribute most of their earnings. Accordingly, this likely explains why its earnings have been shrinking.

In addition, Scentre Group has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 77% of its profits over the next three years. Regardless, the future ROE for Scentre Group is predicted to rise to 5.8% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, Scentre Group's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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