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Most readers would already be aware that Steel Dynamics' (NASDAQ:STLD) stock increased significantly by 56% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Steel Dynamics' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
ROE 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 Steel Dynamics is:
17% = US$819m ÷ US$4.7b (Based on the trailing twelve months to March 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.17 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 17% ROE
At first glance, Steel Dynamics seems to have a decent ROE. Especially when compared to the industry average of 13% the company's ROE looks pretty impressive. This certainly adds some context to Steel Dynamics' decent 17% net income growth seen over the past five years.
We then performed a comparison between Steel Dynamics' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 21% 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. 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?
Steel Dynamics' three-year median payout ratio to shareholders is 25% (implying that it retains 75% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Additionally, Steel Dynamics 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 27%. Still, forecasts suggest that Steel Dynamics' future ROE will drop to 13% even though the the company's payout ratio is not expected to change by much.
On the whole, we feel that Steel Dynamics' performance has been quite good. 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, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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