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Servcorp's (ASX:SRV) stock up by 9.4% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Servcorp's ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Servcorp
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 Servcorp is:
24% = AU$54m ÷ AU$227m (Based on the trailing twelve months to December 2024).
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$0.24.
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.
Servcorp's Earnings Growth And 24% ROE
Firstly, we acknowledge that Servcorp has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 6.1% also doesn't go unnoticed by us. Probably as a result of this, Servcorp was able to see a decent net income growth of 19% over the last five years.
Next, on comparing with the industry net income growth, we found that Servcorp's growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Servcorp's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Servcorp Efficiently Re-investing Its Profits?
While Servcorp has a three-year median payout ratio of 77% (which means it retains 23% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.