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

Most readers would already know that Smiths Group's (LON:SMIN) stock increased by 1.3% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Smiths Group's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See 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£234m ÷ UK£2.1b (Based on the trailing twelve months to January 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Smiths Group's Earnings Growth And 11% ROE

To begin with, Smiths Group seems to have a respectable ROE. On comparing with the average industry ROE of 8.3% the company's ROE looks pretty remarkable. This probably laid the ground for Smiths Group's moderate 14% net income growth seen over the past five years.

Next, on comparing Smiths Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 14% over the last few years.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is SMIN worth today? The intrinsic value infographic in our free research report helps visualize whether SMIN is currently mispriced by the market.

Is Smiths Group Using Its Retained Earnings Effectively?

Smiths Group has a significant three-year median payout ratio of 85%, meaning that it is left with only 15% 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 40% 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 16%, over the same period.

Conclusion

In total, we are pretty happy 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.