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It is hard to get excited after looking at Softcat's (LON:SCT) recent performance, when its stock has declined 6.8% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Softcat's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Softcat
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Softcat is:
40% = UK£119m ÷ UK£298m (Based on the trailing twelve months to July 2024).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.40 in profit.
What Is The Relationship Between ROE And 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Softcat's Earnings Growth And 40% ROE
Firstly, we acknowledge that Softcat has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. This probably laid the groundwork for Softcat's moderate 11% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that Softcat's growth is quite high when compared to the industry average growth of 5.8% 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. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for SCT? You can find out in our latest intrinsic value infographic research report.