1300SMILES (ASX:ONT) has had a rough month with its share price down 5.8%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to 1300SMILES' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for 1300SMILES
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for 1300SMILES is:
17% = AU$7.1m ÷ AU$41m (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.17 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
1300SMILES' Earnings Growth And 17% ROE
At first glance, 1300SMILES seems to have a decent ROE. On comparing with the average industry ROE of 8.1% the company's ROE looks pretty remarkable. Yet, 1300SMILES has posted measly growth of 2.3% over the past five years. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that 1300SMILES' reported growth was lower than the industry growth of 3.2% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ONT fairly valued? This infographic on the company's intrinsic value has everything you need to know.