Is Weakness In Pason Systems Inc. (TSE:PSI) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?
With its stock down 27% over the past three months, it is easy to disregard Pason Systems (TSE:PSI). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Pason Systems' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Pason Systems
How To Calculate Return On Equity?
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 Pason Systems is:
28% = CA$106m ÷ CA$381m (Based on the trailing twelve months to December 2022).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.28 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Pason Systems' Earnings Growth And 28% ROE
Firstly, we acknowledge that Pason Systems has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. Probably as a result of this, Pason Systems was able to see a decent net income growth of 5.9% over the last five years.
We then performed a comparison between Pason Systems' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 5.9% 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. Has the market priced in the future outlook for PSI? You can find out in our latest intrinsic value infographic research report.
Is Pason Systems Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 81% (or a retention ratio of 19%) for Pason Systems suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Moreover, Pason Systems 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 31% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
Summary
In total, we are pretty happy with Pason Systems' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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