Should Weakness in SILK Laser Australia Limited's (ASX:SLA) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

By
Simply Wall St
Published
May 13, 2022
ASX:SLA
Source: Shutterstock

It is hard to get excited after looking at SILK Laser Australia's (ASX:SLA) recent performance, when its stock has declined 36% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study SILK Laser Australia's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for SILK Laser Australia

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 SILK Laser Australia is:

5.1% = AU$4.4m ÷ AU$87m (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.05 in profit.

What Is The Relationship Between ROE And 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 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.

SILK Laser Australia's Earnings Growth And 5.1% ROE

On the face of it, SILK Laser Australia's ROE is not much to talk about. However, its ROE is similar to the industry average of 5.1%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that SILK Laser Australia's net income grew significantly at a rate of 55% over the last five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that SILK Laser Australia's growth is quite high when compared to the industry average growth of 6.8% in the same period, which is great to see.

past-earnings-growth
ASX:SLA Past Earnings Growth May 13th 2022

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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if SILK Laser Australia is trading on a high P/E or a low P/E, relative to its industry.

Is SILK Laser Australia Making Efficient Use Of Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.

Conclusion

In total, it does look like SILK Laser Australia has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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