Is Smartgroup Corporation Ltd's (ASX:SIQ) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

Smartgroup's (ASX:SIQ) stock is up by a considerable 14% 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. In this article, we decided to focus on Smartgroup's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Smartgroup

How To Calculate Return On Equity?

Return on equity 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 Smartgroup is:

24% = AU$57m ÷ AU$232m (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.24 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Smartgroup's Earnings Growth And 24% ROE

To begin with, Smartgroup has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. Despite this, Smartgroup's five year net income growth was quite flat over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital

Next, on comparing with the industry net income growth, we found that Smartgroup's reported growth was lower than the industry growth of 8.7% over the last few years, which is not something we like to see.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is SIQ fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Smartgroup Making Efficient Use Of Its Profits?

Smartgroup has a high three-year median payout ratio of 80% (or a retention ratio of 20%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Additionally, Smartgroup has paid dividends over a period of nine 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 82%. Still, forecasts suggest that Smartgroup's future ROE will rise to 31% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we feel that Smartgroup certainly does have some positive factors to consider. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.