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It is hard to get excited after looking at SDI Group's (LON:SDI) recent performance, when its stock has declined 16% over the past month. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on SDI Group's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for SDI Group
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 SDI Group is:
8.1% = UK£3.5m ÷ UK£43m (Based on the trailing twelve months to October 2024).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.08 in profit.
What Has ROE Got To Do With 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.
SDI Group's Earnings Growth And 8.1% ROE
At first glance, SDI Group's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.4%. On the other hand, SDI Group reported a fairly low 3.0% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.
As a next step, we compared SDI Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 12% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. One 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 may want to check if SDI Group is trading on a high P/E or a low P/E, relative to its industry.