Most readers would already be aware that L.S. Starrett's (NYSE:SCX) stock increased significantly by 68% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study L.S. Starrett's ROE in this article.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
Return on equity 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 L.S. Starrett is:
19% = US$16m ÷ US$84m (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.19 in profit.
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.
L.S. Starrett's Earnings Growth And 19% ROE
To begin with, L.S. Starrett seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 13%. Probably as a result of this, L.S. Starrett was able to see a decent growth of 13% over the last five years.
We then compared L.S. Starrett's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.9% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. One 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 prospects. So, you may want to check if L.S. Starrett is trading on a high P/E or a low P/E, relative to its industry.
Is L.S. Starrett Efficiently Re-investing Its Profits?
L.S. Starrett doesn't pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.
In total, we are pretty happy with L.S. Starrett's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 4 risks we have identified for L.S. Starrett.
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.
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