Smith & Wesson Brands (NASDAQ:SWBI) has had a great run on the share market with its stock up by a significant 11% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Smith & Wesson Brands' ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 Smith & Wesson Brands is:
22% = US$80m ÷ US$367m (Based on the trailing twelve months to October 2022).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.22 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. 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. 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.
Smith & Wesson Brands' Earnings Growth And 22% ROE
At first glance, Smith & Wesson Brands seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 25%. Consequently, this likely laid the ground for the impressive net income growth of 43% seen over the past five years by Smith & Wesson Brands. We believe that there might also be other aspects that are positively influencing the company's earnings growth. 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.
As a next step, we compared Smith & Wesson Brands' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 27%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Smith & Wesson Brands''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Smith & Wesson Brands Using Its Retained Earnings Effectively?
Smith & Wesson Brands' ' three-year median payout ratio is on the lower side at 4.7% implying that it is retaining a higher percentage (95%) of its profits. So it looks like Smith & Wesson Brands is reinvesting profits heavily to grow its business, which shows in its earnings growth.
While Smith & Wesson Brands has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.
In total, we are pretty happy with Smith & Wesson Brands' 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. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.
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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.
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