Step One Clothing Limited's (ASX:STP) Stock Is Going Strong: Have Financials A Role To Play?

Most readers would already be aware that Step One Clothing's (ASX:STP) stock increased significantly by 73% 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 Step One Clothing's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Step One Clothing

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 Step One Clothing is:

15% = AU$8.6m ÷ AU$57m (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.15.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Step One Clothing's Earnings Growth And 15% ROE

To begin with, Step One Clothing seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 19%. Although, we can see that Step One Clothing saw a modest net income growth of 18% over the past five years. So, there might be other aspects that are positively influencing earnings growth. Such as - high earnings retention or an efficient management in place. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.

As a next step, we compared Step One Clothing's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 19% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for STP? You can find out in our latest intrinsic value infographic research report

Is Step One Clothing Making Efficient Use Of Its Profits?

Step One Clothing's high three-year median payout ratio of 108% suggests that the company is paying out more to its shareholders than what it is making. In spite of this, the company was able to grow its earnings respectably, as we saw above. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum. You can see the 2 risks we have identified for Step One Clothing by visiting our risks dashboard for free on our platform here.

Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 100%. Still, forecasts suggest that Step One Clothing's future ROE will rise to 24% even though the the company's payout ratio is not expected to change by much.

Summary

In total, it does look like Step One Clothing has some positive aspects to its business. Specifically, its decent ROE which likely contributed to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the decent rate of return. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.