Spirax-Sarco Engineering’s (LON:SPX) stock up by 5.3% over the past three months. Since the market usually pay for a company’s long-term financial health, we decided to study the company’s fundamentals to see if they could be influencing the market. Particularly, we will be paying attention to Spirax-Sarco Engineering’s ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Spirax-Sarco Engineering is:
20% = UK£168m ÷ UK£841m (Based on the trailing twelve months to June 2020).
The ‘return’ refers to a company’s earnings over the last year. That means that for every £1 worth of shareholders’ equity, the company generated £0.20 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 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 Spirax-Sarco Engineering’s Earnings Growth And 20% ROE
To start with, Spirax-Sarco Engineering’s ROE looks acceptable. Further, the company’s ROE compares quite favorably to the industry average of 12%. Probably as a result of this, Spirax-Sarco Engineering was able to see a decent growth of 15% over the last five years.
As a next step, we compared Spirax-Sarco Engineering’s net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.4%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Spirax-Sarco Engineering fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Spirax-Sarco Engineering Making Efficient Use Of Its Profits?
Spirax-Sarco Engineering has a healthy combination of a moderate three-year median payout ratio of 40% (or a retention ratio of 60%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Additionally, Spirax-Sarco Engineering has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 44%. Accordingly, forecasts suggest that Spirax-Sarco Engineering’s future ROE will be 22% which is again, similar to the current ROE.
On the whole, we feel that Spirax-Sarco Engineering’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 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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