Is Smiths Group plc's (LON:SMIN) Latest Stock Performance Being Led By Its Strong Fundamentals?

Smiths Group's (LON:SMIN) stock up by 6.9% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Smiths Group is:

13% = UK£308m ÷ UK£2.3b (Based on the trailing twelve months to January 2025).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.13 in profit.

View our latest analysis for Smiths Group

Why Is ROE Important For 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. 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 Smiths Group's Earnings Growth And 13% ROE

At first glance, Smiths Group seems to have a decent ROE. Especially when compared to the industry average of 7.4% the company's ROE looks pretty impressive. This certainly adds some context to Smiths Group's exceptional 26% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Smiths Group's growth is quite high when compared to the industry average growth of 8.9% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is SMIN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Smiths Group Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 63% (implying that it keeps only 37% of profits) for Smiths Group suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, Smiths Group 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 38% 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 18%, over the same period.

Conclusion

Overall, we are quite pleased with Smiths Group's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.