Are Robust Financials Driving The Recent Rally In Somero Enterprises, Inc.'s (LON:SOM) Stock?

Somero Enterprises' (LON:SOM) stock is up by a considerable 32% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Somero Enterprises' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Somero Enterprises

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Somero Enterprises is:

35% = US$19m ÷ US$53m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.35 in profit.

What Is The Relationship Between ROE And 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. 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 Somero Enterprises' Earnings Growth And 35% ROE

Firstly, we acknowledge that Somero Enterprises has a significantly high ROE. Secondly, even when compared to the industry average of 8.8% the company's ROE is quite impressive. Probably as a result of this, Somero Enterprises was able to see a decent net income growth of 12% over the last five years.

Next, on comparing with the industry net income growth, we found that Somero Enterprises' growth is quite high when compared to the industry average growth of 8.0% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. Is Somero Enterprises fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Somero Enterprises Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 50% (or a retention ratio of 50%) for Somero Enterprises suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Somero Enterprises is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend.

Summary

On the whole, we feel that Somero Enterprises' performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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