Serco Group plc's (LON:SRP) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 5.0% over the past three months, it is easy to disregard Serco Group (LON:SRP). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Serco Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Serco 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 Serco Group is:

20% = UK£202m ÷ UK£1.0b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.20 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. 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.

Serco Group's Earnings Growth And 20% ROE

At first glance, Serco Group seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. Probably as a result of this, Serco Group was able to see an impressive net income growth of 22% over the last five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then performed a comparison between Serco Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 25% in the same 5-year period.

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 SRP fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Serco Group Making Efficient Use Of Its Profits?

Serco Group has a really low three-year median payout ratio of 17%, meaning that it has the remaining 83% left over to reinvest into its business. So it looks like Serco Group is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Serco 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 30% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 15%, over the same period.

Conclusion

On the whole, we feel that Serco Group's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

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