With its shares down 3.7% over the past month, it’s easy to overlook Scott Technology (NZSE:SCT). We decided to examine the company’s financials to determine if the downtrend will continue, as a company’s long-term performance usually dictates market performance. In this article, we decided to focus on Scott Technology’s ROE.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate a return on the investment it has received from its shareholders. Simply put, it is used to assess a company’s profitability in relation to its equity capital.
Check out our latest analysis on Scott Technology
How is ROE calculated?
The formula for ROE is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Scott Technology is:
9.2% = NZ$9.6 million ÷ NZ$104 million (Based on trailing twelve months to February 2022).
“Return” refers to the company’s earnings over the past year. One way to conceptualize this is that for every NZ$ of shareholder equity it holds, the company has made NZ$0.09 in profit.
What does ROE have to do with revenue growth?
So far we have learned that ROE measures how efficiently a company generates its profits. Based on how much of its earnings the company chooses to reinvest or “hold,” we can then estimate the company’s future ability to generate earnings. All else being equal, the higher the ROE and earnings retention, the higher the growth rate of a company compared to companies that do not necessarily carry these characteristics.
Side by side comparison of Scott Technology’s earnings growth and 9.2% ROE
At first glance, Scott Technology’s ROE isn’t much to talk about. Yet closer examination reveals that the company’s ROE is similar to the industry average of 11%. Having said that, Scott Technology’s five-year net income decline rate is 22%. Note that the company has a somewhat low ROE. Therefore, the decline in profits can also be a result of this.
So, as a next step, we compared Scott Technology’s performance to the industry and we were disappointed to find that while the company has been declining earnings, the industry has been growing at a rate of 7.6% over the same period.
Earnings growth is a huge factor in stock valuation. It is important for the investor to know whether the market has priced in the expected growth (or decline) of the company’s earnings. This then helps them determine whether the stock is set for a bright or dark future. A 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 might want to check whether Scott Technology is trading at a high P/E or a low P/E relative to its industry.
Is Scott Technology using its profits effectively?
With a high three-year average payout ratio of 57% (meaning 43% of earnings are retained), most of Scott Technology’s earnings are paid out to shareholders, which explains the company’s declining earnings. The business is left with only a small pool of capital to reinvest – a vicious cycle that does not benefit the company in the long run.
Additionally, Scott Technology has paid dividends for at least ten years, suggesting that maintaining dividend payments is much more important to management, even if it comes at the expense of business growth.
Overall, we would think carefully before deciding on any investment action involving Scott Technology. The company has seen a lack of earnings growth as a result of retaining very little earnings and what little it retains is reinvested at a very low rate of return. So far, we’ve only skimmed the surface of the company’s past performance by looking at the company’s fundamentals. You can do your own research on Scott Technology and see how it has performed in the past by checking out this FREE detailed graphics of past earnings, revenue and cash flows.
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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts, using only an unbiased methodology, and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. We aim to provide you with long-term focused analysis driven by fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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