Most readers would already be aware that Steel Dynamics' (NASDAQ:STLD) stock increased significantly by 17% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Steel Dynamics' ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Steel Dynamics is:
17% = US$819m ÷ US$4.7b (Based on the trailing twelve months to March 2021).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.17.
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. 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.
Steel Dynamics' Earnings Growth And 17% ROE
To start with, Steel Dynamics' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 15%. This certainly adds some context to Steel Dynamics' moderate 17% net income growth seen over the past five years.
Next, on comparing Steel Dynamics' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 19% in the same period.
Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for STLD? You can find out in our latest intrinsic value infographic research report.
Is Steel Dynamics Efficiently Re-investing Its Profits?
In Steel Dynamics' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 25% (or a retention ratio of 75%), which suggests that the company is investing most of its profits to grow its business.
Additionally, Steel Dynamics has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 18% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
On the whole, we feel that Steel Dynamics' performance has been quite good. 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. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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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