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Is Weakness In Science Group plc (LON:SAG) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 4.9% over the past week, it is easy to disregard Science Group (LON:SAG). 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 Science Group's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Science Group

How Is ROE Calculated?

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 Science Group is:

14% = UK£9.6m ÷ UK£66m (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 £1 of its shareholder's investments, the company generates a profit of £0.14.

What Is The Relationship Between ROE And 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.

Science Group's Earnings Growth And 14% ROE

To begin with, Science Group seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 14%. This certainly adds some context to Science Group's exceptional 20% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Science Group's growth is quite high when compared to the industry average growth of 0.6% in the same period, which is great to see.

past-earnings-growth
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. What is SAG worth today? The intrinsic value infographic in our free research report helps visualize whether SAG is currently mispriced by the market.

Is Science Group Using Its Retained Earnings Effectively?

Science Group's three-year median payout ratio is a pretty moderate 30%, meaning the company retains 70% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Science Group is reinvesting its earnings efficiently.

Moreover, Science Group is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 21% over the next three years.

Conclusion

Overall, we are quite pleased with Science Group'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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 1 risk we have identified for Science Group visit our risks dashboard for free.

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.