# SDI Limited's (ASX:SDI) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

It is hard to get excited after looking at SDI's (ASX:SDI) recent performance, when its stock has declined 10% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on SDI'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for SDI

## How To Calculate Return On Equity?

ROE 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 SDI is:

8.6% = AU\$7.3m ÷ AU\$85m (Based on the trailing twelve months to December 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A\$1 of shareholders' capital it has, the company made A\$0.09 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. 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.

## SDI's Earnings Growth And 8.6% ROE

At first glance, SDI's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.2%. Having said that, SDI has shown a meagre net income growth of 4.7% over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

We then performed a comparison between SDI's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 4.7% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 SDI is trading on a high P/E or a low P/E, relative to its industry.

## Is SDI Using Its Retained Earnings Effectively?

While SDI has a decent three-year median payout ratio of 48% (or a retention ratio of 52%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, SDI 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.

## Summary

In total, it does look like SDI has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 3 risks we have identified for SDI.

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

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.

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