Are Severfield plc's (LON:SFR) Mixed Financials Driving The Negative Sentiment?
With its stock down 10% over the past three months, it is easy to disregard Severfield (LON:SFR). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Severfield's ROE.
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 Severfield
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Severfield is:
7.6% = UK£16m ÷ UK£204m (Based on the trailing twelve months to March 2022).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.08 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Severfield's Earnings Growth And 7.6% ROE
When you first look at it, Severfield's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.1%. Still, Severfield has seen a flat net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So that could also be one of the reasons behind the company's flat growth in earnings.
From the 0.9% decline reported by the industry in the same period, we infer that Severfield and its industry are both shrinking at a similar rate.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is SFR fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Severfield Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 49% (meaning the company retains51% of profits) in the last three-year period, Severfield's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Severfield has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 41%. Regardless, the future ROE for Severfield is predicted to rise to 10% despite there being not much change expected in its payout ratio.
Summary
Overall, we have mixed feelings about Severfield. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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