Declining Stock and Solid Fundamentals: Is The Market Wrong About Pason Systems Inc. (TSE:PSI)?

Pason Systems (TSE:PSI) has had a rough month with its share price down 11%. 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. Specifically, we decided to study Pason Systems' ROE in this article.

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.

View our latest analysis for Pason Systems

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 Pason Systems is:

24% = CA$111m ÷ CA$473m (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.24 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Pason Systems' Earnings Growth And 24% ROE

Firstly, we acknowledge that Pason Systems has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. As a result, Pason Systems' exceptional 33% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Pason Systems' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 56% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. 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 Pason Systems is trading on a high P/E or a low P/E, relative to its industry.

Is Pason Systems Making Efficient Use Of Its Profits?

Pason Systems has a three-year median payout ratio of 34% (where it is retaining 66% of its income) which is not too low or not too high. So it seems that Pason Systems is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Pason Systems 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 40%. Still, forecasts suggest that Pason Systems' future ROE will drop to 18% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that Pason Systems' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.