Will Weakness in SThree plc's (LON:STEM) Stock Prove Temporary Given Strong Fundamentals?
SThree (LON:STEM) has had a rough month with its share price down 2.6%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study SThree's 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for SThree
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for SThree is:
25% = UK£56m ÷ UK£223m (Based on the trailing twelve months to November 2023).
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 £0.25 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
SThree's Earnings Growth And 25% ROE
To begin with, SThree has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. This probably laid the groundwork for SThree's moderate 11% net income growth seen over the past five years.
We then compared SThree's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 7.6% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. 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 STEM worth today? The intrinsic value infographic in our free research report helps visualize whether STEM is currently mispriced by the market.
Is SThree Making Efficient Use Of Its Profits?
With a three-year median payout ratio of 36% (implying that the company retains 64% of its profits), it seems that SThree is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Besides, SThree has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 39%. As a result, SThree's ROE is not expected to change by much either, which we inferred from the analyst estimate of 21% for future ROE.
Conclusion
On the whole, we feel that SThree's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
