It is hard to get excited after looking at Provide IT Sweden’s (NGM:PROVIT) recent performance, when its stock has declined 14% 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. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company’s financial performance. In this article, we decided to focus on Provide IT Sweden’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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.

Check out our latest analysis for Provide IT Sweden

How Do You Calculate Return On Equity?

ROE 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 Provide IT Sweden is:

31% = kr2.3m ÷ kr7.5m (Based on the trailing twelve months to June 2023).

The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each SEK1 of shareholders’ capital it has, the company made SEK0.31 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we’ve learned that ROE is a measure of a company’s profitability. 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. 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 Provide IT Sweden’s Earnings Growth And 31% ROE

Firstly, we acknowledge that Provide IT Sweden has a significantly high ROE. Secondly, even when compared to the industry average of 19% the company’s ROE is quite impressive. Despite this, Provide IT Sweden’s five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that’s limiting the company’s growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Provide IT Sweden’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 14% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. One 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 prospects. So, you may want to check if Provide IT Sweden is trading on a high P/E or a low P/E, relative to its industry.

Is Provide IT Sweden Using Its Retained Earnings Effectively?

Provide IT Sweden has a very high three-year median payout ratio of 132% over the last last three years, which suggests that the company is dipping into more than just its earnings to pay its dividend. This does go some way in explaining the negligible earnings growth seen by Provide IT Sweden. Paying a dividend beyond their means is usually not viable over the long term. That’s a huge risk in our books. You can see the 4 risks we have identified for Provide IT Sweden by visiting our risks dashboard for free on our platform here.

In addition, Provide IT Sweden has been paying dividends over a period of six years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we have mixed feelings about Provide IT Sweden. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. So far, we’ve only made a quick discussion around the company’s earnings growth. You can do your own research on Provide IT Sweden and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.