Most readers would already be aware that Sanbase’s (HKG:8501) stock increased significantly by 29% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Sanbase’s ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You 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 Sanbase is:
20% = HK$28m ÷ HK$140m (Based on the trailing twelve months to December 2019).
The ‘return’ is the yearly profit. That means that for every HK$1 worth of shareholders’ equity, the company generated HK$0.20 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we’ve learnt that ROE is a measure of a company’s profitability. 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.
A Side By Side comparison of Sanbase’s Earnings Growth And 20% ROE
To begin with, Sanbase seems to have a respectable ROE. Especially when compared to the industry average of 10% the company’s ROE looks pretty impressive. This probably laid the ground for Sanbase’s moderate 6.4% net income growth seen over the past five years.
We then compared Sanbase’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 3.5% 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. This then helps them determine if the stock is placed for a bright or bleak future. If you’re wondering about Sanbase’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Sanbase Making Efficient Use Of Its Profits?
Sanbase has a healthy combination of a moderate three-year median payout ratio of 32% (or a retention ratio of 68%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
While Sanbase 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.
On the whole, we feel that Sanbase’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.
If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business.You can see the 3 risks we have identified for Sanbase by visiting our risks dashboard for free on our platform here.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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