Can Morneau Shepell Inc. (TSE:MSI) Performance Keep Up Given Its Mixed Bag Of Fundamentals?

Morneau Shepell's (TSE:MSI) stock up by 6.4% over the past three months. Given that the stock prices usually follow long-term business performance, we wonder if the company's mixed financials could have any adverse effect on its current price price movement Particularly, we will be paying attention to Morneau Shepell's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Morneau Shepell

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 Morneau Shepell is:

7.1% = CA$48m ÷ CA$670m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.07 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Morneau Shepell's Earnings Growth And 7.1% ROE

When you first look at it, Morneau Shepell's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 18%. However, the moderate 14% net income growth seen by Morneau Shepell over the past five years is definitely a positive. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Morneau Shepell'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 11%.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Morneau Shepell is trading on a high P/E or a low P/E, relative to its industry.

Is Morneau Shepell Using Its Retained Earnings Effectively?

The really high three-year median payout ratio of 131% for Morneau Shepell suggests that the company is paying its shareholders more than what it is earning. However, this hasn't really hampered its ability to grow as we saw earlier. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates. Our risks dashboard should have the 3 risks we have identified for Morneau Shepell.

Moreover, Morneau Shepell is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 82% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

Overall, we have mixed feelings about Morneau Shepell. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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