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Samuel Heath & Sons' (LON:HSM) stock is up by a considerable 45% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Samuel Heath & Sons' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Samuel Heath & Sons
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Samuel Heath & Sons is:
13% = UK£594k ÷ UK£4.5m (Based on the trailing twelve months to September 2020).
The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.13.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Samuel Heath & Sons' Earnings Growth And 13% ROE
At first glance, Samuel Heath & Sons seems to have a decent ROE. Especially when compared to the industry average of 5.3% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for Samuel Heath & Sons in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then compared Samuel Heath & Sons' net income growth with the industry and found that the company's growth figure is a bit less than the average industry growth rate of 1.5% in the same period.
Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Samuel Heath & Sons''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.