Are Robust Financials Driving The Recent Rally In Softcat plc's (LON:SCT) Stock?

Softcat's (LON:SCT) stock is up by a considerable 13% 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. Specifically, we decided to study Softcat's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Softcat

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Softcat is:

46% = UK£113m ÷ UK£246m (Based on the trailing twelve months to January 2024).

The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.46 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Softcat's Earnings Growth And 46% ROE

First thing first, we like that Softcat has an impressive ROE. Secondly, even when compared to the industry average of 14% the company's ROE is quite impressive. This probably laid the groundwork for Softcat's moderate 12% net income growth seen over the past five years.

We then compared Softcat's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 16% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Softcat fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Softcat Making Efficient Use Of Its Profits?

Softcat has a three-year median payout ratio of 44%, which implies that it retains the remaining 56% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Softcat has paid dividends over a period of eight 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 63% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

Overall, we are quite pleased with Softcat's performance. 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 a good amount of growth in its earnings. 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 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.