Could The Market Be Wrong About São Martinho S.A. (BVMF:SMTO3) Given Its Attractive Financial Prospects?

With its stock down 16% over the past month, it is easy to disregard São Martinho (BVMF:SMTO3). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on São Martinho's 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 São Martinho

How To 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 São Martinho is:

22% = R$1.5b ÷ R$6.9b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every R$1 worth of equity, the company was able to earn R$0.22 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. 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.

São Martinho's Earnings Growth And 22% ROE

At first glance, São Martinho seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to São Martinho's exceptional 20% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared São Martinho's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 16%.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is SMTO3 worth today? The intrinsic value infographic in our free research report helps visualize whether SMTO3 is currently mispriced by the market.

Is São Martinho Making Efficient Use Of Its Profits?

São Martinho has a three-year median payout ratio of 36% (where it is retaining 64% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and São Martinho is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, São Martinho 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 63% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 13% over the same period.

Summary

On the whole, we feel that São Martinho'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, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com