DS Smith Plc's (LON:SMDS) Stock Is Going Strong: Is the Market Following Fundamentals?

Most readers would already be aware that DS Smith's (LON:SMDS) stock increased significantly by 15% over the past three months. 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 DS Smith's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for DS Smith

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for DS Smith is:

12% = UK£464m ÷ UK£4.0b (Based on the trailing twelve months to October 2023).

The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.12.

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.

DS Smith's Earnings Growth And 12% ROE

At first glance, DS Smith seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. This certainly adds some context to DS Smith's moderate 12% net income growth seen over the past five years.

We then performed a comparison between DS Smith's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 12% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if DS Smith is trading on a high P/E or a low P/E, relative to its industry.

Is DS Smith Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 65% (or a retention ratio of 35%) for DS Smith suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, DS Smith 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 is expected to keep paying out approximately 53% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 11%.

Conclusion

On the whole, we feel that DS Smith's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.