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DS Smith (LON:SMDS) had a tough three months, falling 19%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we have chosen to focus on DS Smith’s ROE.
ROE, or return on equity, is a useful tool for assessing how effectively a company is generating returns on the investment received from its shareholders. In short, ROE shows the profit each dollar generates in relation to its shareholders’ investments.
Check out our latest analysis for DS Smith
How is ROE calculated?
That Formula for ROE is:
Return on Equity = Net Income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for DS Smith is:
6.5% = £243 million ÷ £3.7 billion (based on trailing 12 months to October 2021).
The “return” is the annual profit. So this means that for every £1 of investment by its shareholders, the company makes £0.07 of profit.
What is the relationship between ROE and earnings growth?
So far we’ve learned that ROE measures how efficiently a company generates its profits. Based on how much of its profits the company reinvests, or “retains,” we are then able to assess a company’s future ability to generate profits. Assuming all else remains the same, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.
A head-to-head comparison of DS Smith’s earnings growth and 6.5% ROE
At first glance, the DS Smith’s ROE doesn’t look particularly attractive. Next, the company’s ROE leaves us even less excited compared to the industry average ROE of 11%. Therefore, DS Smith’s flat earnings over the past five years could likely be the result of lower ROE.
Next, when we compare it to industry net income growth, we found that DS Smith’s reported growth was lower than industry growth of 8.0% over the same period, which we don’t like to see.
Earnings growth is an important metric to consider when evaluating a stock. Next, investors need to determine whether expected earnings growth, or lack thereof, is already embedded in the stock price. This allows them to determine if the stock’s future looks bright or ominous. If you’re wondering about DS Smith’s valuation, check out this benchmark of price-to-earnings versus its industry.
Is DS Smith using its profits efficiently?
The high three-year average payout ratio of 76% (which means the company only retains 24% of earnings) for DS Smith suggests that the company’s earnings growth has been minimal due to paying out a majority of its earnings.
Additionally, DS Smith has been paying dividends for at least a decade, suggesting that management must have recognized that shareholders prefer dividends to earnings growth. Examining the latest analyst consensus data, we found that the company’s future payout ratio is expected to drop to 46% over the next three years. The fact that the company’s ROE is expected to increase to 12% over the same period can be explained by the decline in the payout ratio.
summary
Overall, we would think carefully before making any investment move regarding DS Smith. The company has experienced a lack of earnings growth as it retains very little earnings and what little it retains is reinvested at a very low rate of return. Against this backdrop, the latest forecasts from industry analysts indicate that the company’s profits are expected to accelerate. To learn more about the latest analyst forecasts for the company, check out this visualization of analyst forecasts for the company.
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This Simply Wall St article is of a general nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
