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Most readers would already be aware that J. M. Smucker's (NYSE:SJM) stock increased significantly by 18% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to J. M. Smucker's ROE today.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 J. M. Smucker is:
12% = US$956m ÷ US$8.2b (Based on the trailing twelve months to January 2021).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.12 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
J. M. Smucker's Earnings Growth And 12% ROE
To begin with, J. M. Smucker seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Despite the moderate return on equity, J. M. Smucker has posted a net income growth of 4.5% over the past five years. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.
As a next step, we compared J. M. Smucker's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 1.3%.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is SJM fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is J. M. Smucker Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 47% (or a retention ratio of 53% over the past three years, J. M. Smucker has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, J. M. Smucker 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 44%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 11%.
On the whole, we feel that J. M. Smucker's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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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