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With its stock down 14% over the past three months, it is easy to disregard Sono-Tek (NASDAQ:SOTK). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Sono-Tek'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Sono-Tek
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Sono-Tek is:
10% = US$1.7m ÷ US$17m (Based on the trailing twelve months to May 2024).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.10.
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. 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. 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.
A Side By Side comparison of Sono-Tek's Earnings Growth And 10% ROE
When you first look at it, Sono-Tek's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 10%, we may spare it some thought. Having said that, Sono-Tek has shown a modest net income growth of 8.6% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Sono-Tek's reported growth was lower than the industry growth of 15% over the last few years, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Sono-Tek's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.