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Sanderson Design Group plc's (LON:SDG) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Sanderson Design Group's (LON:SDG) stock is up by a considerable 36% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Sanderson Design Group's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Sanderson Design Group

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 Sanderson Design Group is:

0.5% = UK£329k ÷ UK£61m (Based on the trailing twelve months to July 2020).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Sanderson Design Group's Earnings Growth And 0.5% ROE

It is hard to argue that Sanderson Design Group's ROE is much good in and of itself. Even compared to the average industry ROE of 6.8%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 11% seen by Sanderson Design Group over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Sanderson Design Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 6.9% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Sanderson Design Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Sanderson Design Group Efficiently Re-investing Its Profits?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.

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 30%. Still, forecasts suggest that Sanderson Design Group's future ROE will rise to 8.2% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we have mixed feelings about Sanderson Design Group. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.

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

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