Most readers would already know that Sonoco Products’ (NYSE:SON) stock increased by 8.2% over the past three months. We wonder if and what role the company’s financials play in that price change as a company’s long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Sonoco Products’ 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. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
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 Sonoco Products is:
17% = US$299m ÷ US$1.8b (Based on the trailing twelve months to March 2020).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.17 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we’ve learned 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.
Sonoco Products’ Earnings Growth And 17% ROE
To begin with, Sonoco Products seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 16%. Sonoco Products’ decent returns aren’t reflected in Sonoco Products’mediocre five year net income growth average of 4.5%. A few likely reasons that could be keeping earnings growth low are – the company has a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that Sonoco Products’ reported growth was lower than the industry growth of 14% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you’re wondering about Sonoco Products”s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Sonoco Products Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 56% (or a retention ratio of 44%), most of Sonoco Products’ profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.
Additionally, Sonoco Products has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 53%. Therefore, the company’s future ROE is also not expected to change by much with analysts predicting an ROE of 17%.
Overall, we feel that Sonoco Products certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. 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 company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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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