Are Strong Financial Prospects The Force That Is Driving The Momentum In SM Entertainment Co., Ltd.'s KOSDAQ:041510) Stock?

SM Entertainment's (KOSDAQ:041510) stock is up by a considerable 14% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on SM Entertainment'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 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 SM Entertainment is:

20% = ₩241b ÷ ₩1.2t (Based on the trailing twelve months to March 2025).

The 'return' refers to a company's earnings over the last year. So, this means that for every ₩1 of its shareholder's investments, the company generates a profit of ₩0.20.

See our latest analysis for SM Entertainment

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of SM Entertainment's Earnings Growth And 20% ROE

At first glance, SM Entertainment seems to have a decent ROE. Especially when compared to the industry average of 9.4% the company's ROE looks pretty impressive. Probably as a result of this, SM Entertainment was able to see an impressive net income growth of 34% over the last five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that SM Entertainment's growth is quite high when compared to the industry average growth of 7.9% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 SM Entertainment is trading on a high P/E or a low P/E, relative to its industry.

Is SM Entertainment Making Efficient Use Of Its Profits?

SM Entertainment's three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. So it seems that SM Entertainment is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, SM Entertainment is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 20% over the next three years. Still forecasts suggest that SM Entertainment's future ROE will drop to 15% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.

Conclusion

In total, we are pretty happy with SM Entertainment'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 substantial growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.