Declining Stock and Decent Financials: Is The Market Wrong About Samuel Heath & Sons plc (LON:HSM)?

Samuel Heath & Sons (LON:HSM) has had a rough three months with its share price down 13%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Samuel Heath & Sons' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Samuel Heath & Sons

How Do You Calculate Return On Equity?

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 Samuel Heath & Sons is:

12% = UK£1.3m ÷ UK£11m (Based on the trailing twelve months to September 2022).

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 £0.12 in profit.

What Has ROE Got To Do With 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. 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.

A Side By Side comparison of Samuel Heath & Sons' Earnings Growth And 12% ROE

At first glance, Samuel Heath & Sons seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 15% does temper our expectations. Although, we can see that Samuel Heath & Sons saw a modest net income growth of 8.5% over the past five years. So, there might be other aspects that are positively influencing earnings growth. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also provides some context to the earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Samuel Heath & Sons' reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.

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. 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 Samuel Heath & Sons is trading on a high P/E or a low P/E, relative to its industry.

Is Samuel Heath & Sons Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 25% (implying that the company retains 75% of its profits), it seems that Samuel Heath & Sons is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Samuel Heath & Sons has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

Overall, we feel that Samuel Heath & Sons certainly does have some positive factors to consider. Specifically, we like that the company is reinvesting a huge chunk of its profits at a respectable rate of return. This of course has caused the company to see a good amount of growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Samuel Heath & Sons visit our risks dashboard for free.

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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