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Most readers would already be aware that SBS Transit's (SGX:S61) stock increased significantly by 20% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Particularly, we will be paying attention to SBS Transit's ROE today.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To 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 SBS Transit is:
9.8% = S$70m ÷ S$719m (Based on the trailing twelve months to December 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each SGD1 of shareholders' capital it has, the company made SGD0.10 in profit.
Check out our latest analysis for SBS Transit
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. 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.
SBS Transit's Earnings Growth And 9.8% ROE
At first glance, SBS Transit's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 8.5%, we may spare it some thought. But SBS Transit saw a five year net income decline of 2.7% over the past five years. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.
So, as a next step, we compared SBS Transit's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 22% over the last few years.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 SBS Transit is trading on a high P/E or a low P/E, relative to its industry.