With its stock down 29% over the past three months, it is easy to disregard Simulations Plus (NASDAQ:SLP). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Simulations Plus' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 Simulations Plus is:
7.1% = US$12m ÷ US$165m (Based on the trailing twelve months to May 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.07 in profit.
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. 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.
Simulations Plus' Earnings Growth And 7.1% ROE
At first glance, Simulations Plus' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.0%. Having said that, Simulations Plus has shown a modest net income growth of 16% over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing Simulations Plus' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 SLP fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Simulations Plus Using Its Retained Earnings Effectively?
Simulations Plus has a three-year median payout ratio of 46%, which implies that it retains the remaining 54% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Besides, Simulations Plus has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders.
Overall, we feel that Simulations Plus certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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. 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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