Is the market wrong on Sims Limited (ASX:SGM)?
With its stock down 15% in the last three months, it’s easy to overlook The Sims (ASX:SGM). However, stock prices are usually determined by a company’s long-term finances, which in this case seem quite respectable. In this article, we decided to focus on the ROE of Sims.
Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In simple terms, it is used to assess the profitability of a company in relation to its equity.
Check out our latest analysis for The Sims
How is ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Sims is:
19% = AU$430 million ÷ AU$2.3 billion (based on trailing 12 months to December 2021).
“Yield” is the income the business has earned over the past year. One way to conceptualize this is that for every Australian dollar of share capital it has, the company has made a profit of 0.19 Australian dollars.
Why is ROE important for earnings growth?
So far, we have learned that ROE measures how efficiently a company generates its profits. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to gauge a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and better earnings retention are generally the ones with a higher growth rate compared to companies that don’t. same characteristics.
Sims revenue growth and 19% ROE
For starters, Sims seems to have a respectable ROE. Even when compared to the industry average of 16%, the company’s ROE looks pretty decent. Because of this, Sims’ 10% drop in net income over five years raises the question of why decent ROE hasn’t translated into growth. Based on this, we believe that there might be other reasons which have not been discussed so far in this article which might hinder the growth of the business. These include poor revenue retention or poor capital allocation.
That being said, we benchmarked Sims’ performance against the industry and were concerned when we found that while the company had cut profits, the industry had increased profits at a rate of 26% over the course of the year. same period.
Earnings growth is an important metric to consider when evaluating a stock. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. A good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings outlook. So, you might want to check if Sims is trading on a high P/E or on a low P/E, relative to its industry.
Are Sims effectively using their retained earnings?
Considering his three-year median payout rate of 34% (or a 66% retention rate), which is fairly normal, Sims’ revenue decline is rather disconcerting, as one would expect to see good growth when a company keeps a good part of its profits. It seems that there could be other reasons for the lack in this regard. For example, the business might be in decline.
Additionally, Sims has paid dividends over a period of at least ten years, which means the company’s management is committed to paying dividends even if it means little or no earnings growth. Our latest analyst data shows that the company’s future payout ratio over the next three years is expected to be around 33%. Either way, Sims’ ROE is expected to drop to 14% despite no expected change in its payout ratio.
Overall, we think The Sims definitely has some positives to consider. However, we are disappointed to see a lack of earnings growth, even despite a high ROE and high reinvestment rate. We believe that there could be external factors that could negatively impact the business. Moreover, the latest forecasts from industry analysts show that analysts expect the company’s earnings to continue to decline in the future. To learn more about the latest analyst forecasts for the company, check out this analyst forecast visualization for the company.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.