BlueScope Steel's (ASX:BSL) stock up by 6.6% 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 investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on BlueScope Steel'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 BlueScope Steel is:
1.8% = AU$128m ÷ AU$7.0b (Based on the trailing twelve months to June 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$0.02.
Why Is ROE Important For 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.
A Side By Side comparison of BlueScope Steel's Earnings Growth And 1.8% ROE
It is hard to argue that BlueScope Steel's ROE is much good in and of itself. Even when compared to the industry average of 12%, the ROE figure is pretty disappointing. BlueScope Steel was still able to see a decent net income growth of 19% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that BlueScope Steel's reported growth was lower than the industry growth of 34% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 BlueScope Steel's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is BlueScope Steel Making Efficient Use Of Its Profits?
In BlueScope Steel's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 7.3% (or a retention ratio of 93%), which suggests that the company is investing most of its profits to grow its business.
Additionally, BlueScope Steel has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 14% over the next three years. Regardless, the future ROE for BlueScope Steel is speculated to rise to 8.4% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
In total, it does look like BlueScope Steel has some positive aspects to its business. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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