Most readers would already be aware that Schaffer's (ASX:SFC) stock increased significantly by 11% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Schaffer's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Schaffer is:
26% = AU$37m ÷ AU$141m (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.26.
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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Schaffer's Earnings Growth And 26% ROE
Firstly, we acknowledge that Schaffer has a significantly high ROE. Secondly, even when compared to the industry average of 20% the company's ROE is quite impressive. As a result, Schaffer's exceptional 36% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared Schaffer'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 15%.
Earnings growth is an important metric to consider when valuing a stock. 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 Schaffer fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Schaffer Making Efficient Use Of Its Profits?
Schaffer's three-year median payout ratio is a pretty moderate 39%, meaning the company retains 61% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Schaffer is reinvesting its earnings efficiently.
Besides, Schaffer has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.
On the whole, we feel that Schaffer's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 2 risks we have identified for Schaffer.
If you’re looking to trade Schaffer, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.