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Johnson Service Group PLC's (LON:JSG) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Simply Wall St

It is hard to get excited after looking at Johnson Service Group's (LON:JSG) recent performance, when its stock has declined 6.1% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Johnson Service Group's ROE in this article.

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.

View our latest analysis for Johnson Service Group

How To Calculate Return On Equity?

Return on equity 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 Johnson Service Group is:

0.9% = UK£2.5m ÷ UK£280m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.01 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Johnson Service Group's Earnings Growth And 0.9% ROE

It is quite clear that Johnson Service Group's ROE is rather low. Not just that, even compared to the industry average of 11%, the company's ROE is entirely unremarkable. Johnson Service Group was still able to see a decent net income growth of 7.6% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Johnson Service Group's reported growth was lower than the industry growth of 9.7% in the same period, which is not something we like to see.

past-earnings-growth
past-earnings-growth

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

Is Johnson Service Group Making Efficient Use Of Its Profits?

Johnson Service Group has a healthy combination of a moderate three-year median payout ratio of 40% (or a retention ratio of 60%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Our latest analyst data shows that the future payout ratio of the company is expected to drop to 32% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 11%, over the same period.

Conclusion

Overall, we feel that Johnson Service Group certainly does have some positive factors to consider. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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.

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