Most readers would already be aware that Scentre Group's (ASX:SCG) stock increased significantly by 5.1% over the past week. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Scentre Group's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Scentre Group

How Do You Calculate Return On Equity?

The formula for ROE is:

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

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

1.7% = AU$322m ÷ AU$19b (Based on the trailing twelve months to December 2022).

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.

What Is The Relationship Between ROE And 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. 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.

Scentre Group's Earnings Growth And 1.7% ROE

As you can see, Scentre Group's ROE looks pretty weak. Not just that, even compared to the industry average of 9.7%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 41% seen by Scentre Group was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Scentre Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 22% in the same period. This is quite worrisome.

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 SCG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Scentre Group Making Efficient Use Of Its Profits?

Scentre Group has a very high three-year median payout ratio of 78%, implying that it retains only 22% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. So this probably explains the company's shrinking earnings.

Additionally, Scentre Group has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 78% of its profits over the next three years. Still, forecasts suggest that Scentre Group's future ROE will rise to 6.5% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Scentre Group. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.

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.

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