Smartgroup Corporation Ltd's (ASX:SIQ) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Most readers would already be aware that Smartgroup's (ASX:SIQ) stock increased significantly by 15% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. 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.

Check out 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:

15% = AU$41m ÷ AU$271m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.15.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Smartgroup's Earnings Growth And 15% ROE

To start with, Smartgroup's ROE looks acceptable. Even when compared to the industry average of 13% the company's ROE looks quite decent. This certainly adds some context to Smartgroup's moderate 15% net income growth seen over the past five years.

As a next step, we compared Smartgroup'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 8.6%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is SIQ worth today? The intrinsic value infographic in our free research report helps visualize whether SIQ is currently mispriced by the market.

Is Smartgroup Efficiently Re-investing Its Profits?

Smartgroup has a significant three-year median payout ratio of 90%, meaning that it is left with only 9.8% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Smartgroup is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 68% over the next three years. As a result, the expected drop in Smartgroup's payout ratio explains the anticipated rise in the company's future ROE to 27%, over the same period.

Summary

Overall, we feel that Smartgroup certainly does have some positive factors to consider. Especially the growth in earnings which was backed by an impressive ROE. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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