Sanderson Design Group plc (LON:SDG) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

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Simply Wall St

Sun, May 15, 2022, 1:28 AM 4 min read

Sanderson Design Group (LON:SDG) has had a rough three months with its share price down 24%. 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. In this article, we decided to focus on Sanderson Design Group's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Sanderson Design Group

How Do You Calculate Return On Equity?

Return on equity 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 Sanderson Design Group is:

9.7% = UK£7.8m ÷ UK£80m (Based on the trailing twelve months to January 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Sanderson Design Group's Earnings Growth And 9.7% ROE

To start with, Sanderson Design Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 11%. For this reason, Sanderson Design Group's five year net income decline of 8.3% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Sanderson Design Group's earnings seems to be shrinking at a similar rate as the industry which shrunk at a rate of a rate of 7.8% in the same period.

past-earnings-growth — AIM:SDG Past Earnings Growth May 15th 2022

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Sanderson Design Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sanderson Design Group Making Efficient Use Of Its Profits?

When we piece together Sanderson Design Group's low three-year median payout ratio of 9.9% (where it is retaining 90% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Sanderson Design Group has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 26% over the next three years. Regardless, the future ROE for Sanderson Design Group is speculated to rise to 19% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

In total, it does look like Sanderson Design Group has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.