SPS Commerce, Inc.'s (NASDAQ:SPSC) Stock Is Going Strong: Is the Market Following Fundamentals?
SPS Commerce's (NASDAQ:SPSC) stock is up by a considerable 30% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to SPS Commerce's ROE today.
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.
View our latest analysis for SPS Commerce
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for SPS Commerce is:
10% = US$41m ÷ US$395m (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 in profit.
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. 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.
SPS Commerce's Earnings Growth And 10% ROE
To start with, SPS Commerce's ROE looks acceptable. Even when compared to the industry average of 13% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 51% seen over the past five years by SPS Commerce. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared SPS Commerce's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 30% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is SPS Commerce fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is SPS Commerce Using Its Retained Earnings Effectively?
Conclusion
Overall, we are quite pleased with SPS Commerce's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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