Signet Jewelers Limited's (NYSE:SIG) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Signet Jewelers (NYSE:SIG) has had a rough three months with its share price down 22%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Signet Jewelers' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Signet Jewelers

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 Signet Jewelers is:

32% = US$765m ÷ US$2.4b (Based on the trailing twelve months to May 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.32 in profit.

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 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.

Signet Jewelers' Earnings Growth And 32% ROE

First thing first, we like that Signet Jewelers has an impressive ROE. Secondly, even when compared to the industry average of 20% the company's ROE is quite impressive. So, the substantial 49% net income growth seen by Signet Jewelers over the past five years isn't overly surprising.

As a next step, we compared Signet Jewelers' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 21%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Signet Jewelers is trading on a high P/E or a low P/E, relative to its industry.

Is Signet Jewelers Making Efficient Use Of Its Profits?

Signet Jewelers' ' three-year median payout ratio is on the lower side at 7.4% implying that it is retaining a higher percentage (93%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Signet Jewelers is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 10% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 22%, over the same period.

Conclusion

On the whole, we feel that Signet Jewelers' 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. 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. 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. 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.