Spectra Systems Corporation's (LON:SPSC) Stock Price Has Stayed Flat But Financial Prospects Look Decent: Can The Market Catch Up?
It is easy to overlook Spectra Systems' (LON:SPSC) given its unimpressive and roughly flat price performance over the past week. However, attentive investors would probably give more consideration to the stock as the company's fundamentals could add more to the story, given how long-term financials are usually what drive market prices. In this article, we decided to focus on Spectra Systems' 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.
Check out our latest analysis for Spectra Systems
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Spectra Systems is:
18% = US$5.1m ÷ US$28m (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.18 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Spectra Systems' Earnings Growth And 18% ROE
To begin with, Spectra Systems seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.8%. This certainly adds some context to Spectra Systems' exceptional 28% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Spectra Systems' growth is quite high when compared to the industry average growth of 9.2% in the same period, which is great to see.
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. Is Spectra Systems fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Spectra Systems Using Its Retained Earnings Effectively?
Spectra Systems' significant three-year median payout ratio of 92% (where it is retaining only 8.0% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Additionally, Spectra Systems has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders.
Summary
On the whole, we do feel that Spectra Systems has some positive attributes. Specifically, its high ROE which likely led to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the high rate of return. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Spectra Systems' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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.
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