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With its stock down 9.0% over the past three months, it is easy to disregard Spirent Communications (LON:SPT). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Spirent Communications' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Spirent Communications
How Is ROE Calculated?
ROE 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 Spirent Communications is:
20% = US$82m ÷ US$411m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.20 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. 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.
Spirent Communications' Earnings Growth And 20% ROE
To begin with, Spirent Communications seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 14%. This probably laid the ground for Spirent Communications' significant 49% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Spirent Communications' growth is quite high when compared to the industry average growth of 29% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for SPT? You can find out in our latest intrinsic value infographic research report.