Is The Market Rewarding Smiths Group plc (LON:SMIN) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
With its stock down 5.6% over the past three months, it is easy to disregard Smiths Group (LON:SMIN). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Smiths Group's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Smiths Group
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 Smiths Group is:
9.4% = UK£226m ÷ UK£2.4b (Based on the trailing twelve months to July 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.09.
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.
A Side By Side comparison of Smiths Group's Earnings Growth And 9.4% ROE
To begin with, Smiths Group seems to have a respectable ROE. Even when compared to the industry average of 8.9% the company's ROE looks quite decent. Smiths Group's decent returns aren't reflected in Smiths Group'smediocre five year net income growth average of 2.6%. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then compared Smiths Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same 5-year period, which is a bit concerning.
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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for SMIN? You can find out in our latest intrinsic value infographic research report.
Is Smiths Group Using Its Retained Earnings Effectively?
Smiths Group has a very high three-year median payout ratio of 121%suggesting that the company's shareholders are getting paid from more than just the company's income. This is quite a risky position to be in.
Moreover, Smiths Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 40% over the next three years. The fact that the company's ROE is expected to rise to 15% over the same period is explained by the drop in the payout ratio.
Conclusion
In total, we're a bit ambivalent about Smiths Group's performance. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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.