Does The Market Have A Low Tolerance For Sipa Resources Limited's (ASX:SRI) Mixed Fundamentals?

Sipa Resources (ASX:SRI) has had a rough three months with its share price down 34%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Sipa Resources' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Sipa Resources

How Do You 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 Sipa Resources is:

4.5% = AU$129k ÷ AU$2.9m (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.04 in profit.

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 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.

Sipa Resources' Earnings Growth And 4.5% ROE

On the face of it, Sipa Resources' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10% either. Accordingly, Sipa Resources' low net income growth of 2.3% over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Sipa Resources' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 21% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Sipa Resources''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sipa Resources Using Its Retained Earnings Effectively?

Sipa Resources doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business. However, there's only been very little earnings growth to show for it. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Summary

In total, we're a bit ambivalent about Sipa Resources' performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for Sipa Resources visit our risks dashboard for free.

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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.