Singapore Technologies Engineering (SGX:S63) has had a rough three months with its share price down 20%. 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 Singapore Technologies Engineering's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Singapore Technologies Engineering

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 Singapore Technologies Engineering is:

24% = S$593m ÷ S$2.5b (Based on the trailing twelve months to December 2019).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.24 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learnt 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. 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.

A Side By Side comparison of Singapore Technologies Engineering's Earnings Growth And 24% ROE

Firstly, we acknowledge that Singapore Technologies Engineering has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 7.8% also doesn't go unnoticed by us. However, we are curious as to how the high returns still resulted in a flat growth for Singapore Technologies Engineering in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital

We then compared Singapore Technologies Engineering's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same period, which is a bit concerning.

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. Has the market priced in the future outlook for S63? You can find out in our latest intrinsic value infographic research report.

Is Singapore Technologies Engineering Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 68% (meaning, the company retains only 32% of profits) for Singapore Technologies Engineering suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Moreover, Singapore Technologies Engineering has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 76%. Accordingly, forecasts suggest that Singapore Technologies Engineering's future ROE will be 27% which is again, similar to the current ROE.

Summary

Overall, we feel that Singapore Technologies Engineering certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.