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Should Weakness in XRF Scientific Limited's (ASX:XRF) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Simply Wall St
·4 min read

With its stock down 4.8% over the past month, it is easy to disregard XRF Scientific (ASX:XRF). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study XRF Scientific's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for XRF Scientific

How Is ROE Calculated?

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 XRF Scientific is:

8.8% = AU$3.1m ÷ AU$36m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

XRF Scientific's Earnings Growth And 8.8% ROE

At first glance, XRF Scientific's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 11%. Having said that, XRF Scientific has shown a modest net income growth of 9.5% over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared XRF Scientific's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 35% in the same period, which is a bit concerning.

past-earnings-growth
past-earnings-growth

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about XRF Scientific's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is XRF Scientific Using Its Retained Earnings Effectively?

XRF Scientific has a three-year median payout ratio of 39%, which implies that it retains the remaining 61% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, XRF Scientific has been paying dividends over a period of nine years. 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 is expected to rise to 59% over the next three years. Still, forecasts suggest that XRF Scientific's future ROE will rise to 11% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

On the whole, we do feel that XRF Scientific has some positive attributes. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.