In This Article:
It is hard to get excited after looking at Synlait Milk's (NZSE:SML) recent performance, when its stock has declined 8.3% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Synlait Milk's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Synlait Milk
How Do You Calculate Return On Equity?
ROE 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 Synlait Milk is:
14% = NZ$71m ÷ NZ$520m (Based on the trailing twelve months to January 2020).
The 'return' is the yearly profit. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.14.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Synlait Milk's Earnings Growth And 14% ROE
To start with, Synlait Milk's ROE looks acceptable. Especially when compared to the industry average of 7.8% the company's ROE looks pretty impressive. This probably laid the ground for Synlait Milk's significant 34% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Synlait Milk's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 12%.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Synlait Milk fairly valued compared to other companies? These 3 valuation measures might help you decide.