SMU S.A.'s (SNSE:SMU) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

SMU (SNSE:SMU) has had a great run on the share market with its stock up by a significant 14% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study SMU's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for SMU

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 SMU is:

2.8% = CL$20b ÷ CL$715b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each CLP1 of shareholders' capital it has, the company made CLP0.03 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. 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. 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 SMU's Earnings Growth And 2.8% ROE

As you can see, SMU's ROE looks pretty weak. Even compared to the average industry ROE of 9.9%, the company's ROE is quite dismal. However, we we're pleasantly surprised to see that SMU grew its net income at a significant rate of 53% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared SMU's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.3% in the same 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. If you're wondering about SMU's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is SMU Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 53% (implying that it keeps only 47% of profits) for SMU suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Along with seeing a growth in earnings, SMU only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 46%. Regardless, the future ROE for SMU is predicted to rise to 7.6% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we feel that SMU certainly does have some positive factors to consider. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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. 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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