Steel Dynamics (NASDAQ:STLD) has had a rough three months with its share price down 22%. 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 Steel Dynamics' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You 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 Steel Dynamics is:
16% = US$664m ÷ US$4.1b (Based on the trailing twelve months to March 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.16 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Steel Dynamics' Earnings Growth And 16% ROE
To start with, Steel Dynamics' ROE looks acceptable. Especially when compared to the industry average of 13% the company's ROE looks pretty impressive. This probably laid the ground for Steel Dynamics' significant 41% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Steel Dynamics' growth is quite high when compared to the industry average growth of 30% 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. What is STLD worth today? The intrinsic value infographic in our free research report helps visualize whether STLD is currently mispriced by the market.
Is Steel Dynamics Efficiently Re-investing Its Profits?
The three-year median payout ratio for Steel Dynamics is 32%, which is moderately low. The company is retaining the remaining 68%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Steel Dynamics is reinvesting its earnings efficiently.
Moreover, Steel Dynamics is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 42% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 12%, over the same period.
On the whole, we feel that Steel Dynamics' performance has been quite good. 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 sizeable 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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