Does the market follow fundamentals?

Most readers would already know that shares of Softcat (LON:SCT) are up significantly by 15% in the last month. Since the market usually pays for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could influence the market. In particular, today we will pay attention to the ROE of Softcat.

Return on equity or ROE is a key measure used to evaluate how efficiently the management of a business uses the company’s capital. In other words, it is a profitability ratio that measures the rate of return on capital provided by the company’s shareholders.

Check out our latest analysis for Softcat

How to calculate the return on equity?

The return on equity can be calculated using the formula:

Return on Equity = Net income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for Softcat is:

52% = UK £110m ÷ UK £211m (based on twelve months to July 2022).

The “return” is the income the business has earned in the past year. So, this means that for every pound of its shareholder’s investments, the company generates a profit of 0.52 pounds.

What is the relationship between ROE and earnings growth?

We’ve learned so far that ROE is a measure of a company’s profitability. Based on the amount of profits the company chooses to reinvest or “hold”, we are then able to assess a company’s future ability to generate profits. Assuming everything else remains the same, the higher the ROE and earnings retention, the higher the growth rate of a company compared to companies that do not necessarily have these characteristics.

A side-by-side comparison of Softcat’s earnings growth and ROE of 52%.

For starters, Softcat has a pretty high ROE which is interesting. Second, even compared to the industry average of 8.0%, the company’s ROE is pretty impressive. This likely set the stage for Softcat’s moderate 19% net income growth over the past five years.

Next, when comparing to industry net income growth, we found that Softcat’s reported growth was less than 25% industry growth over the same period, which is not something we like to see.

past earnings growth

Earnings growth is an important metric to consider when evaluating a stock. It is important for an investor to know whether the market has valued the growth (or decline) in the company’s expected earnings. This will help them determine whether the title’s future looks promising or ominous. If you’re wondering about Softcat’s valuation, check out this indicator of its price-earnings ratio, relative to its industry.

Is Softcat making efficient use of its profits?

With an average three-year payout of 43% (implying the company retains 57% of its profits), Softcat appears to be reinvesting efficiently to see respectable growth in its earnings and pay a well-covered dividend. .

Additionally, Softcat is determined to continue sharing its profits with shareholders, which we can tell from its long seven-year history of paying dividends. After studying the latest analyst consensus data, we found that the company’s future pay ratio is expected to rise to 63% over the next three years. Therefore, the projected increase in the payout ratio explains why the company’s ROE is expected to decline to 38% over the same period.

Summary

Overall, we’re quite happy with Softcat’s performance. Specifically, we like that the company is reinvesting a large chunk of its profits at a high rate of return. This of course has caused the company to see good growth in its earnings. That said, the company’s earnings growth is expected to slow, as expected in current analyst estimates. To learn more about the latest analyst forecasts for the company, check out this view of analyst forecasts for the company.

Do you have feedback on this article? Concerned about the content? Get in touch directly with us. Alternatively, please email editorial-team (at) simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using unbiased methodology only and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis driven by fundamental data. Please 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 of the stocks mentioned.

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