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Is Samuel Heath & Sons plc's (LON:HSM) Recent Stock Performance Tethered To Its Strong Fundamentals?

Samuel Heath & Sons (LON:HSM) has had a great run on the share market with its stock up by a significant 6.8% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Samuel Heath & Sons' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Samuel Heath & Sons

How To Calculate Return On Equity?

The formula for ROE is:

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Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Samuel Heath & Sons is:

19% = UK£1.5m ÷ UK£7.7m (Based on the trailing twelve months to March 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.19 in profit.

What Is The Relationship Between ROE And 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 Samuel Heath & Sons' Earnings Growth And 19% ROE

At first glance, Samuel Heath & Sons seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. Yet, Samuel Heath & Sons has posted measly growth of 2.1% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Samuel Heath & Sons' 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 1.0%.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Samuel Heath & Sons''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Samuel Heath & Sons Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 26% (or a retention ratio of 74% over the past three years, Samuel Heath & Sons has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Samuel Heath & Sons has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

Overall, we are quite pleased with Samuel Heath & Sons' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Samuel Heath & Sons by visiting our risks dashboard for free on our platform here.

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.

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