Solid State plc (LON:SOLI) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

With its stock down 19% over the past three months, it is easy to disregard Solid State (LON:SOLI). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Solid State's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Solid State

How Do You 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 Solid State is:

6.8% = UK£4.1m ÷ UK£60m (Based on the trailing twelve months to September 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 £0.07.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Solid State's Earnings Growth And 6.8% ROE

At first glance, Solid State's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.3%. Even so, Solid State has shown a fairly decent growth in its net income which grew at a rate of 10%. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Given that the industry shrunk its earnings at a rate of 1.6% in the same period, the net income growth of the company is quite impressive.

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. Has the market priced in the future outlook for SOLI? You can find out in our latest intrinsic value infographic research report.

Is Solid State Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 35% (implying that the company retains 65% of its profits), it seems that Solid State is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Solid State is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

In total, it does look like Solid State has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.