Softcat plc (LON:SCT) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?
Softcat (LON:SCT) has had a rough three months with its share price down 9.9%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Softcat's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Softcat
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 Softcat is:
63% = UK£102m ÷ UK£163m (Based on the trailing twelve months to January 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.63 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. 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.
Softcat's Earnings Growth And 63% ROE
Firstly, we acknowledge that Softcat has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 9.6% also doesn't go unnoticed by us. Probably as a result of this, Softcat was able to see a decent net income growth of 20% over the last five years.
As a next step, we compared Softcat's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 25% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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 Softcat fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Softcat Efficiently Re-investing Its Profits?
Softcat has a three-year median payout ratio of 43%, which implies that it retains the remaining 57% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Besides, Softcat has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 64% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 47% over the same period.
Summary
On the whole, we feel that Softcat's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
