Is Weakness In SHAPE Australia Corporation Limited (ASX:SHA) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

view original post

SHAPE Australia (ASX:SHA) has had a rough month with its share price down 8.9%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to SHAPE Australia’s 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. Put another way, it reveals the company’s success at turning shareholder investments into profits.

View our latest analysis for SHAPE Australia

How Do You Calculate Return On Equity?

ROE 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 SHAPE Australia is:

53% = AU$12m ÷ AU$23m (Based on the trailing twelve months to December 2021).

The ‘return’ is the profit over the last twelve months. So, this means that for every A$1 of its shareholder’s investments, the company generates a profit of A$0.53.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.

A Side By Side comparison of SHAPE Australia’s Earnings Growth And 53% ROE

To begin with, SHAPE Australia has a pretty high ROE which is interesting. 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 SHAPE Australia’s moderate 13% net income growth seen over the past five years.

Next, on comparing SHAPE Australia’s net income growth with the industry, we found that the company’s reported growth is similar to the industry average growth rate of 14% in the same period.

past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 SHAPE Australia is trading on a high P/E or a low P/E, relative to its industry.

Is SHAPE Australia Efficiently Re-investing Its Profits?

SHAPE Australia’s three-year median payout ratio to shareholders is 21% (implying that it retains 79% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Our latest analyst data shows that the future payout ratio of the company is expected to rise to 83% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company’s ROE to 38%, over the same period.

Summary

In total, we are pretty happy with SHAPE Australia’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. 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.