Could The Market Be Wrong About Softcat plc (LON:SCT) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Softcat's (LON:SCT) recent performance, when its stock has declined 14% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Softcat's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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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:

45% = UK£125m ÷ UK£281m (Based on the trailing twelve months to January 2025).

The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.45 in profit.

Check out our latest analysis for Softcat

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. 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.

A Side By Side comparison of Softcat's Earnings Growth And 45% ROE

First thing first, we like that Softcat has an impressive ROE. Secondly, even when compared to the industry average of 21% the company's ROE is quite impressive. Probably as a result of this, Softcat was able to see a decent net income growth of 9.5% over the last five years.

As a next step, we compared Softcat's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 9.5% in the same period.

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). Doing so will help them establish if the stock's future looks promising or ominous. Is Softcat fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Softcat Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 44% (implying that the company retains 56% of its profits), it seems that Softcat is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Softcat has paid dividends over a period of nine 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 71% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

On the whole, we feel that Softcat's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.