SL Green Realty Corp.'s (NYSE:SLG) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Most readers would already be aware that SL Green Realty's (NYSE:SLG) stock increased significantly by 25% 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. Specifically, we decided to study SL Green Realty's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for SL Green Realty

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for SL Green Realty is:

4.2% = US$239m ÷ US$5.7b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.04.

Why Is ROE Important For 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of SL Green Realty's Earnings Growth And 4.2% ROE

It is quite clear that SL Green Realty's ROE is rather low. Not just that, even compared to the industry average of 5.4%, the company's ROE is entirely unremarkable. Hence, the flat earnings seen by SL Green Realty over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared SL Green Realty's net income growth with the industry and discovered that the industry saw an average growth of 12% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for SLG? You can find out in our latest intrinsic value infographic research report.

Is SL Green Realty Efficiently Re-investing Its Profits?

SL Green Realty has a very high three-year median payout ratio of 51% (or a retention ratio of 49%). However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. Accordingly, this suggests that the company's earnings growth was miniscule as a result of the high payout.

Additionally, SL Green Realty has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 48% of its profits over the next three years. Regardless, SL Green Realty's ROE is speculated to decline to -0.5% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on SL Green Realty. 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. Additionally, the latest industry analyst forecasts show that analysts expect the company's earnings to continue to shrink 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. 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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