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SEEK's (ASX:SEK) stock is up by 6.2% over the past three months. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Specifically, we decided to study SEEK's ROE in this article.
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.
View our latest analysis for SEEK
How Do You 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 SEEK is:
13% = AU$241m ÷ AU$1.9b (Based on the trailing twelve months to June 2022).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.13.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
SEEK's Earnings Growth And 13% ROE
To begin with, SEEK seems to have a respectable ROE. Even so, when compared with the average industry ROE of 16%, we aren't very excited. Further research shows that SEEK's net income has shrunk at a rate of 18% over the last five years. Bear in mind, the company does have a high ROE. It is just that the industry ROE is higher. Hence there might be some other aspects that are causing earnings to shrink. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
However, when we compared SEEK's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 0.1% in the same period. This is quite worrisome.
Earnings growth is an important metric to consider when valuing a stock. 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. Is SEK fairly valued? This infographic on the company's intrinsic value has everything you need to know.