Most readers would already be aware that Softcat’s (LON:SCT) stock increased significantly by 15% over the past month. 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. Particularly, we will be paying attention to Softcat’s ROE today.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
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 Softcat is:
52% = UK£110m ÷ UK£211m (Based on the trailing twelve months to July 2022).
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 £0.52.
What Is The Relationship Between ROE And 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 Softcat’s Earnings Growth And 52% ROE
To begin with, Softcat has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 8.0% the company’s ROE is quite impressive. This probably laid the groundwork for Softcat’s moderate 19% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that Softcat’s reported growth was lower than the industry growth of 25% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. 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. If you’re wondering about Softcat’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Softcat Making Efficient Use Of Its Profits?
With a three-year median payout ratio of 43% (implying that the company retains 57% of its profits), it seems that Softcat is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that’s well covered.
Moreover, Softcat is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to rise to 63% over the next three years. Therefore, the expected rise in the payout ratio explains why the company’s ROE is expected to decline to 38% over the same period.
Overall, we are quite pleased with Softcat’s performance. 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 a good amount of growth in its earnings. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
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