Sims' (ASX:SGM) stock is up by a considerable 11% over the past month. 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 Sims' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To 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 Sims is:
24% = AU$599m ÷ AU$2.5b (Based on the trailing twelve months to June 2022).
The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.24.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
Sims' Earnings Growth And 24% ROE
First thing first, we like that Sims has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. Probably as a result of this, Sims was able to see a decent net income growth of 12% over the last five years.
We then compared Sims' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 33% in the same period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for SGM? You can find out in our latest intrinsic value infographic research report.
Is Sims Using Its Retained Earnings Effectively?
With a three-year median payout ratio of 31% (implying that the company retains 69% of its profits), it seems that Sims is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Additionally, Sims 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 is expected to keep paying out approximately 35% of its profits over the next three years. However, Sims' future ROE is expected to decline to 8.3% despite there being not much change anticipated in the company's payout ratio.
In total, we are pretty happy with Sims' performance. 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 respectable growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.
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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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