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Pason Systems Inc. (TSE:PSI) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Pason Systems' (TSE:PSI) stock is up by a considerable 33% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Pason Systems' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Pason Systems

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 Pason Systems is:

6.2% = CA$19m ÷ CA$307m (Based on the trailing twelve months to September 2021).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.06 in profit.

What Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of Pason Systems' Earnings Growth And 6.2% ROE

On the face of it, Pason Systems' ROE is not much to talk about. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. Despite this, surprisingly, Pason Systems saw an exceptional 23% net income growth over the past five years. So, 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 the growth figure reported by Pason Systems compares quite favourably to the industry average, which shows a decline of 1.9% in the same period.

past-earnings-growth
past-earnings-growth

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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Pason Systems is trading on a high P/E or a low P/E, relative to its industry.

Is Pason Systems Using Its Retained Earnings Effectively?

Pason Systems' very high three-year median payout ratio of 117% suggests that the company is paying more to its shareholders than what it is earning. Despite this, the company's earnings grew significantly as we saw above. Having said that, the high payout ratio is definitely risky and something to keep an eye on. To know the 2 risks we have identified for Pason Systems visit our risks dashboard for free.

Additionally, Pason Systems has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 27% over the next three years. The fact that the company's ROE is expected to rise to 17% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we feel that the performance shown by Pason Systems can be open to many interpretations. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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.

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

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