With its stock down 3.5% over the past three months, it is easy to disregard Signify (AMS:LIGHT). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Signify's ROE in this article.

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 Signify

How To 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 Signify is:

9.4% = €274m ÷ €2.9b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.09.

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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Signify's Earnings Growth And 9.4% ROE

At first glance, Signify seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 13% does temper our expectations. Additionally, the flat earnings seen by Signify over the past five years doesn't paint a very bright picture. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. Hence there might be some other aspects that are causing the flat growth in earnings. These include low earnings retention or poor capital allocation.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 21% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Signify's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Signify Making Efficient Use Of Its Profits?

Despite having a moderate three-year median payout ratio of 47% (meaning the company retains53% of profits) in the last three-year period, Signify's earnings growth was more or les flat. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Signify has paid dividends over a period of eight years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 52%. However, Signify's ROE is predicted to rise to 13% despite there being no anticipated change in its payout ratio.

Summary

In total, it does look like Signify has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.