Yahoo Finance Service Stream Limited (ASX:SSM) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?
Service Stream (ASX:SSM) has had a rough three months with its share price down 20%. 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. Specifically, we decided to study Service Stream's 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Service Stream
How Do You 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 Service Stream is:
12% = AU$38m ÷ AU$320m (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$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. 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. 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.
Service Stream's Earnings Growth And 12% ROE
At first glance, Service Stream seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Consequently, this likely laid the ground for the decent growth of 19% seen over the past five years by Service Stream.
As a next step, we compared Service Stream's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 20% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Service Stream is trading on a high P/E or a low P/E, relative to its industry.
Is Service Stream Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 69% (or a retention ratio of 31%) for Service Stream suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Additionally, Service Stream has paid dividends over a period of nine 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 54% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
Conclusion
On the whole, we feel that Service Stream's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. 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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
