Can Mixed Financials Have A Negative Impact on DS Smith Plc's 's (LON:SMDS) Current Price Momentum?

DS Smith's (LON:SMDS) stock up by 8.3% over the past three months. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Specifically, we decided to study DS Smith'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for DS Smith

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 DS Smith is:

8.2% = UK£377m ÷ UK£4.6b (Based on the trailing twelve months to October 2022).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.08.

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. 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.

DS Smith's Earnings Growth And 8.2% ROE

On the face of it, DS Smith's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. DS Smith was still able to see a decent net income growth of 5.0% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that DS Smith's reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is SMDS worth today? The intrinsic value infographic in our free research report helps visualize whether SMDS is currently mispriced by the market.

Is DS Smith Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 73% (or a retention ratio of 27%) for DS Smith suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, DS Smith has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 47% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 10%, over the same period.

Summary

In total, we're a bit ambivalent about DS Smith's performance. While no doubt its earnings growth is pretty respectable, the low profit retention could mean that the company's earnings growth could have been higher, had it been paying reinvesting a higher portion of its profits. An improvement in its ROE could also help future earnings growth. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.