It is hard to get excited after looking at Synlait Milk's (NZSE:SML) recent performance, when its stock has declined 13% 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. Particularly, we will be paying attention to Synlait Milk's ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
Return on equity 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 Synlait Milk is:
12% = NZ$75m ÷ NZ$606m (Based on the trailing twelve months to July 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.12 in profit.
Why Is ROE Important For 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. 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.
Synlait Milk's Earnings Growth And 12% ROE
At first glance, Synlait Milk seems to have a decent ROE. Especially when compared to the industry average of 7.7% the company's ROE looks pretty impressive. Probably as a result of this, Synlait Milk was able to see an impressive net income growth of 25% over the last five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
We then compared Synlait Milk'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 6.9% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is Synlait Milk fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Synlait Milk Efficiently Re-investing Its Profits?
In total, we are pretty happy with Synlait Milk's performance. 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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