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SAP (ETR:SAP) has had a great run on the share market with its stock up by a significant 11% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to SAP's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for SAP
How To 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 SAP is:
6.1% = €2.8b ÷ €46b (Based on the trailing twelve months to September 2022).
The 'return' is the income the business earned over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.06.
What Is The Relationship Between ROE And 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. 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.
SAP's Earnings Growth And 6.1% ROE
When you first look at it, SAP's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 5.3% net income growth seen by SAP over the past five years is definitely a positive. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.
We then compared SAP's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 19% in the same period, which is a bit concerning.
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). This then helps them determine if the stock is placed for a bright or bleak future. Is SAP fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is SAP Using Its Retained Earnings Effectively?
With a three-year median payout ratio of 44% (implying that the company retains 56% of its profits), it seems that SAP is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.