Stantec (TSE:STN) has had a rough three months with its share price down 12%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Stantec’s ROE.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Stantec is:
10% = CA$201m ÷ CA$2.0b (Based on the trailing twelve months to December 2021).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders’ capital it has, the company made CA$0.10 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. 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 Stantec’s Earnings Growth And 10% ROE
To start with, Stantec’s ROE looks acceptable. Be that as it may, the company’s ROE is still quite lower than the industry average of 17%. Although, we can see that Stantec saw a modest net income growth of 12% over the past five years. We reckon that there could be other factors at play here. Such as – high earnings retention or an efficient management in place. 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 does lend some color to the fairly high earnings growth seen by the company.
As a next step, we compared Stantec’s net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 23% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is STN worth today? The intrinsic value infographic in our free research report helps visualize whether STN is currently mispriced by the market.
Is Stantec Making Efficient Use Of Its Profits?
With a three-year median payout ratio of 37% (implying that the company retains 63% of its profits), it seems that Stantec is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that’s well covered.
Moreover, Stantec is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 22% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 16%, over the same period.
On the whole, we do feel that Stantec has some positive attributes. 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. Having said that, looking at the current analyst estimates, we found that the company’s earnings are expected to gain momentum. 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.
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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.