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Could The Market Be Wrong About Spirax-Sarco Engineering plc (LON:SPX) Given Its Attractive Financial Prospects?

Spirax-Sarco Engineering (LON:SPX) has had a rough three months with its share price down 15%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Spirax-Sarco Engineering'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 Spirax-Sarco Engineering

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 Spirax-Sarco Engineering is:

23% = UK£235m ÷ UK£1.0b (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.23.

Why Is ROE Important For Earnings Growth?

So far, we've learned 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Spirax-Sarco Engineering's Earnings Growth And 23% ROE

Firstly, we acknowledge that Spirax-Sarco Engineering has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. This probably laid the groundwork for Spirax-Sarco Engineering's moderate 8.0% net income growth seen over the past five years.

As a next step, we compared Spirax-Sarco Engineering's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 7.5% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Spirax-Sarco Engineering fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Spirax-Sarco Engineering Efficiently Re-investing Its Profits?

Spirax-Sarco Engineering has a three-year median payout ratio of 44%, which implies that it retains the remaining 56% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Spirax-Sarco Engineering has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 41%. Accordingly, forecasts suggest that Spirax-Sarco Engineering's future ROE will be 21% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Spirax-Sarco Engineering's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.