Spectra Systems Corporation's (LON:SPSC) Been Flat But Financials Look Strong: Can The Market Catch Up?

It is easy to overlook Spectra Systems' (LON:SPSC) given its unimpressive and roughly flat price performance over the past week. Regardless, it's worth giving the company a closer given that its key financial performance indicators look pretty strong and that's usually rewarded by the markets in the long-run. Specifically, we decided to study Spectra Systems' 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.

Check out our latest analysis for Spectra Systems

How Do You 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 Spectra Systems is:

18% = US$4.2m ÷ US$24m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.18 in profit.

Why Is ROE Important For Earnings Growth?

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

Spectra Systems' Earnings Growth And 18% ROE

To begin with, Spectra Systems seems to have a respectable ROE. On comparing with the average industry ROE of 8.8% the company's ROE looks pretty remarkable. Probably as a result of this, Spectra Systems was able to see an impressive net income growth of 37% over the last five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Spectra Systems' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 17% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Spectra Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Spectra Systems Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 75% (implying that it keeps only 25% of profits) for Spectra Systems suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, Spectra Systems has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

On the whole, we feel that Spectra Systems' performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Up till now, we've only made a short study of the company's growth data. To gain further insights into Spectra Systems' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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This article by Simply Wall St is general in nature. 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.
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