Has Washington H. Soul Pattinson and Company Limited's (ASX:SOL) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Most readers would already be aware that Washington H. Soul Pattinson's (ASX:SOL) stock increased significantly by 14% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Washington H. Soul Pattinson's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Washington H. Soul Pattinson

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Washington H. Soul Pattinson is:

17% = AU$1.4b ÷ AU$8.5b (Based on the trailing twelve months to January 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.17 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. 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.

Washington H. Soul Pattinson's Earnings Growth And 17% ROE

To begin with, Washington H. Soul Pattinson seems to have a respectable ROE. Even when compared to the industry average of 20% the company's ROE looks quite decent. Despite the modest returns, Washington H. Soul Pattinson's five year net income growth was quite low, averaging at only 2.6%. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then compared Washington H. Soul Pattinson's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 23% in the same period, which is a bit concerning.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Washington H. Soul Pattinson's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Washington H. Soul Pattinson Using Its Retained Earnings Effectively?

Washington H. Soul Pattinson's low three-year median payout ratio of 15% (or a retention ratio of 85%) should mean that the company is retaining most of its earnings to fuel its growth. However, the low earnings growth number doesn't reflect this fact. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Washington H. Soul Pattinson has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 177% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 2.6%, over the same period.

Conclusion

In total, it does look like Washington H. Soul Pattinson has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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. 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.