Profit ratio

Should weakness in Select Harvests Limited (ASX:SHV) stock be taken as a sign that the market will correct the stock price given decent financials?

With its stock down 19% in the past month, it’s easy to overlook Select Harvests (ASX: SHV). However, the company’s fundamentals look pretty decent and long-term financial data is generally in line with future market price movements. In particular, we’ll be paying attention to the ROE of Select Harvests today.

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

Check out our latest analysis for Select Harvests

How to calculate return on equity?

The ROE formula is:

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

So, based on the above formula, the ROE for Select Harvests is:

4.9% = AU$26 million ÷ AU$531 million (based on trailing 12 months to March 2022).

“Yield” is the income the business has earned over the past year. Another way to think about this is that for every 1 Australian dollar of equity, the company was able to make a profit of 0.05 Australian dollars.

Why is ROE important for earnings growth?

We have already established that ROE serves as an effective profit-generating indicator for a company’s future earnings. Depending on how much of its profits the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.

A side-by-side comparison of Select Harvests earnings growth and ROE of 4.9%

At first glance, Select Harvests’ ROE does not look very promising. We then compared the company’s ROE to the entire industry and were disappointed to see that the ROE is below the industry average of 8.1%. However, we can see that Select Harvests has experienced modest net income growth of 18% over the past five years. Thus, the company’s earnings growth could likely have been caused by other variables. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio.

Then, comparing with the industry net income growth, we found that Select Harvests’ growth is quite high compared to the average industry growth of 13% over the same period, which is great to see.

ASX: SHV Past Earnings Growth June 30, 2022

The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. This will help them determine if the future of the title looks bright or ominous. Is Select Harvests fairly valued relative to other companies? These 3 assessment metrics might help you decide.

Is Select Harvests effectively using its retained earnings?

With a three-year median payout ratio of 41% (implying the company retains 59% of its earnings), it appears that Select Harvests is effectively reinvesting to see respectable earnings growth and paying a dividend that is well covered.

Additionally, Select Harvests has paid dividends over a period of at least ten years, which means the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the company’s future payout ratio is expected to reach 58% over the next three years. Regardless, Select Harvests’ future ROE is expected to reach 11% despite the expected increase in the payout ratio. There could likely be other factors that could drive future ROE growth.

Summary

Overall, we think Select Harvests certainly has positive factors to consider. With a high reinvestment rate, albeit at a low ROE, the company managed to see considerable growth in earnings. That said, the latest analyst forecasts show that the company will continue to see earnings expansion. Are these analyst expectations based on general industry expectations or company fundamentals? Click here to access our analyst forecast page for the company.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.