It is hard to get excited after looking at SBS Transit's (SGX:S61) recent performance, when its stock has declined 4.7% over the past three months. 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 SBS Transit's ROE.

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.

See our latest analysis for SBS Transit

How To Calculate Return On Equity?

ROE 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 SBS Transit is:

11% = S$68m ÷ S$644m (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each SGD1 of shareholders' capital it has, the company made SGD0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

SBS Transit's Earnings Growth And 11% ROE

To begin with, SBS Transit seems to have a respectable ROE. On comparing with the average industry ROE of 7.1% the company's ROE looks pretty remarkable. As you might expect, the 2.0% net income decline reported by SBS Transit is a bit of a surprise. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

That being said, we compared SBS Transit's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.5% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about SBS Transit's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.