Most readers would already be aware that Simonds Group’s (ASX:SIO) stock increased significantly by 21% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Simonds Group’s ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Put another way, it reveals the company’s success at turning shareholder investments into profits.
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 Simonds Group is:
26% = AU$4.9m ÷ AU$18m (Based on the trailing twelve months to December 2020).
The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.26 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Simonds Group’s Earnings Growth And 26% ROE
Firstly, we acknowledge that Simonds Group has a significantly high ROE. Secondly, even when compared to the industry average of 21% the company’s ROE is quite impressive. Under the circumstances, Simonds Group’s considerable five year net income growth of 21% was to be expected.
We then compared Simonds Group’s net income growth with the industry and we’re pleased to see that the company’s growth figure is higher when compared with the industry which has a growth rate of 7.9% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Simonds Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Simonds Group Using Its Retained Earnings Effectively?
Simonds Group doesn’t pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what’s driving the high earnings growth number discussed above.
In total, we are pretty happy with Simonds Group’s performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard would have the 2 risks we have identified for Simonds Group.
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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