Declining Stock and Solid Fundamentals: Is The Market Wrong About Smiths Group plc (LON:SMIN)?

It is hard to get excited after looking at Smiths Group's (LON:SMIN) recent performance, when its stock has declined 4.2% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Smiths Group's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Smiths Group

How To Calculate Return On Equity?

ROE 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 Smiths Group is:

11% = UK£251m ÷ UK£2.3b (Based on the trailing twelve months to July 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.11 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. 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 Smiths Group's Earnings Growth And 11% ROE

At first glance, Smiths Group seems to have a decent ROE. On comparing with the average industry ROE of 8.6% the company's ROE looks pretty remarkable. Probably as a result of this, Smiths Group was able to see a decent growth of 17% over the last five years.

As a next step, we compared Smiths Group's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 16% in the same period.

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. Has the market priced in the future outlook for SMIN? You can find out in our latest intrinsic value infographic research report.

Is Smiths Group Efficiently Re-investing Its Profits?

Smiths Group has a significant three-year median payout ratio of 65%, meaning that it is left with only 35% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, Smiths Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 39% over the next three years. As a result, the expected drop in Smiths Group's payout ratio explains the anticipated rise in the company's future ROE to 19%, over the same period.

Conclusion

On the whole, we feel that Smiths Group's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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. 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.