Has Washington H. Soul Pattinson and Company Limited's (ASX:SOL) Impressive Stock Performance Got Anything to Do With Its Fundamentals?
Washington H. Soul Pattinson's (ASX:SOL) stock is up by a considerable 13% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Washington H. Soul Pattinson's ROE.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Washington H. Soul Pattinson
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 Washington H. Soul Pattinson is:
17% = AU$1.4b ÷ AU$8.5b (Based on the trailing twelve months to January 2023).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.17 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.
Washington H. Soul Pattinson's Earnings Growth And 17% ROE
To begin with, Washington H. Soul Pattinson seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 19%. Despite the modest returns, Washington H. Soul Pattinson's five year net income growth was quite low, averaging at only 2.6%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that Washington H. Soul Pattinson's reported growth was lower than the industry growth of 23% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Washington H. Soul Pattinson's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Washington H. Soul Pattinson Making Efficient Use Of Its Profits?
Washington H. Soul Pattinson has a low three-year median payout ratio of 15% (meaning, the company keeps the remaining 85% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this fact. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, Washington H. Soul Pattinson has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 177% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 2.6%, over the same period.
Summary
In total, it does look like Washington H. Soul Pattinson has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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