With its stock down 20% over the past three months, it is easy to disregard Scana (OB:SCANA). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Scana'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Scana is:
75% = kr59m ÷ kr78m (Based on the trailing twelve months to March 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every NOK1 worth of equity, the company was able to earn NOK0.75 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Scana's Earnings Growth And 75% ROE
Firstly, we acknowledge that Scana has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. So, the substantial 67% net income growth seen by Scana over the past five years isn't overly surprising.
We then compared Scana's 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 16% 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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Scana is trading on a high P/E or a low P/E, relative to its industry.
Is Scana Making Efficient Use Of Its Profits?
Scana doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.
On the whole, we feel that Scana's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 4 risks we have identified for Scana.
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