Most readers will already know that the Smith & Nephews (LON:SN.) share price has increased by a hefty 22% over the past three months. However, since it is ultimately a company's long-term financial performance that determines market outcomes, we decided to focus on its weak fundamentals in this article. In particular, I would like to pay attention to Smith & Nephew's ROE today.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it receives from its shareholders. More simply, it measures a company's profitability in relation to shareholder equity.
Check out our latest analysis for Smith & Nephew.
How is ROE calculated?
Return on equity can be calculated using the following formula:
Return on equity = Net income (from continuing operations) ÷ Shareholders' equity
So, based on the above formula, Smith & Nephew's ROE is:
4.2% = USD 218 million ÷ USD 5.2 billion (based on trailing twelve months to July 2023).
“Revenue” is the income a company has earned over the past year. That means for every £1 of shareholders' equity, the company generated £0.04 in profit.
What relationship does ROE have with profit growth?
So far, we have learned that ROE is a measure of a company's profitability. Now we need to assess how much profit the company reinvests or “retains” for future growth, which gives us an idea about the company's growth potential. Generally speaking, other things being equal, companies with high return on equity and profit retention will have higher growth rates than companies without these attributes.
A side-by-side comparison of Smith & Nephew's earnings growth and ROE 4.2%
At first glance, Smith & Nephew's ROE doesn't look very attractive. However, ROE is on par with the industry average of 4.3%, so we can't completely rule it out. However, Smith & Nephew's net income has declined by 17% over the past five years. Note that the company's ROE is slightly lower. Therefore, this can explain the contraction in earnings to some extent.
Next, we find that Smith & Nephew's performance remains quite bleak when compared to an industry whose profits have shrunk at a rate of 9.5% over the same five-year period. industry.
The foundations that give a company value have a lot to do with its revenue growth. It's important for investors to know whether the market is pricing in a company's expected earnings growth (or decline). This can help you decide whether to position the stock for a bright or bleak future. What is SN? Is it worth it today? The Intrinsic Value infographic in our free research report will help you visualize whether you are an SN. Currently, the market is mispricing.
Is Smith & Nephew effectively utilizing its retained earnings?
The decline in Smith & Nephew's profits is significant, given that the company spends most of its profits paying dividends, as judged by its three-year median payout ratio of 70% (or retention rate of 30%). , not surprising. The business is left with only a small amount of capital that can be reinvested. This is a vicious cycle that does not benefit the company in the long run. The Risks Dashboard should now show the four risks he has identified regarding Smith & Nephew.
Additionally, Smith & Nephew has been paying dividends for at least 10 years, suggesting that management must have known that shareholders wanted dividends more than earnings growth. . After researching the latest analyst consensus data, we find that the company's future dividend payout ratio is expected to drop to 42% over the next three years. Therefore, the expected drop in dividend payout ratio explains that the company's ROE is expected to rise to his 16% over the same period.
summary
In total, you should think twice before deciding on any investment action regarding Smith & Nephew. The company hasn't been reinvesting much in its business, and given its low ROE, it's no surprise that its earnings aren't growing or growing at all. Having said that, a look at current analyst forecasts shows that the company's earnings growth is expected to improve significantly. Learn more about the company's future revenue growth forecasts here. free Create a report on analyst forecasts to learn more about the company.
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This article by Simply Wall St is general in nature. We provide commentary using only unbiased methodologies, based on historical data and analyst forecasts, and articles are not intended to be financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.
