Is Weakness In Spectra Products Inc. (CVE:SSA) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 11% over the past month, it is easy to disregard Spectra Products (CVE:SSA). 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 Spectra Products' ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Spectra Products

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 Spectra Products is:

53% = CA$711k ÷ CA$1.3m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.53.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Spectra Products' Earnings Growth And 53% ROE

To begin with, Spectra Products has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 10% which is quite remarkable. Under the circumstances, Spectra Products' considerable five year net income growth of 48% was to be expected.

Given that the industry shrunk its earnings at a rate of 7.9% in the same period, the net income growth of the company is quite impressive.

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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for SSA? You can find out in our latest intrinsic value infographic research report

Is Spectra Products Using Its Retained Earnings Effectively?

Summary

In total, we are pretty happy with Spectra Products' performance. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 3 risks we have identified for Spectra Products visit our risks dashboard for free.

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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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