Will Weakness in Smartfit Escola de Ginástica e Dança S.A.'s (BVMF:SMFT3) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Smartfit Escola de Ginástica e Dança's (BVMF:SMFT3) recent performance, when its stock has declined 3.8% over the past week. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Smartfit Escola de Ginástica e Dança'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Smartfit Escola de Ginástica e Dança

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 Smartfit Escola de Ginástica e Dança is:

20% = R$1.0b ÷ R$5.1b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every R$1 worth of shareholders' equity, the company generated R$0.20 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of Smartfit Escola de Ginástica e Dança's Earnings Growth And 20% ROE

To start with, Smartfit Escola de Ginástica e Dança's ROE looks acceptable. Especially when compared to the industry average of 17% the company's ROE looks pretty impressive. This certainly adds some context to Smartfit Escola de Ginástica e Dança's decent 18% net income growth seen over the past five years.

We then performed a comparison between Smartfit Escola de Ginástica e Dança's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 21% in the same 5-year period.

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. 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 Smartfit Escola de Ginástica e Dança is trading on a high P/E or a low P/E, relative to its industry.

Is Smartfit Escola de Ginástica e Dança Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 49% (implying that the company retains 51% of its profits), it seems that Smartfit Escola de Ginástica e Dança is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

While Smartfit Escola de Ginástica e Dança has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 16% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

On the whole, we feel that Smartfit Escola de Ginástica e Dança's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.