With its stock down 3.8% over the past three months, it is easy to disregard SDI (ASX:SDI). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study SDI's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for SDI
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 is:
8.0% = AU$7.1m ÷ AU$88m (Based on the trailing twelve months to June 2023).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
SDI's Earnings Growth And 8.0% ROE
At first glance, SDI's ROE doesn't look very promising. However, its ROE is similar to the industry average of 8.9%, so we won't completely dismiss the company. On the other hand, SDI reported a fairly low 2.1% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.
We then compared SDI's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 5.6% in the same 5-year period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is SDI fairly valued? This infographic on the company's intrinsic value has everything you need to know.