Smith & Nephew’s (LON:SN.) stock is up by 4.8% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Smith & Nephew’s ROE today.
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.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Smith & Nephew is:
12% = US$600m ÷ US$5.1b (Based on the trailing twelve months to December 2019).
The ‘return’ is the yearly profit. So, this means that for every £1 of its shareholder’s investments, the company generates a profit of £0.12.
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. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.
A Side By Side comparison of Smith & Nephew’s Earnings Growth And 12% ROE
To begin with, Smith & Nephew seems to have a respectable ROE. Even when compared to the industry average of 11% the company’s ROE looks quite decent. This certainly adds some context to Smith & Nephew’s moderate 7.9% net income growth seen over the past five years.
As a next step, we compared Smith & Nephew’s net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 36% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is SN. worth today? The intrinsic value infographic in our free research report helps visualize whether SN. is currently mispriced by the market.
Is Smith & Nephew Making Efficient Use Of Its Profits?
Smith & Nephew has a three-year median payout ratio of 45%, which implies that it retains the remaining 55% 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, Smith & Nephew has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 38% of its profits over the next three years. Regardless, the future ROE for Smith & Nephew is predicted to rise to 16% despite there being not much change expected in its payout ratio.
On the whole, we feel that Smith & Nephew’s performance has been quite good. In particular, it’s great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company’s earnings are expected to gain momentum. 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.
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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.
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