It is hard to get excited after looking at SBS Transit's (SGX:S61) recent performance, when its stock has declined 4.7% over the past three months. 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. In this article, we decided to focus on SBS Transit's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for SBS Transit

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 SBS Transit is:

11% = S$68m ÷ S$644m (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each SGD1 of shareholders' capital it has, the company made SGD0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

SBS Transit's Earnings Growth And 11% ROE

To begin with, SBS Transit seems to have a respectable ROE. On comparing with the average industry ROE of 7.1% the company's ROE looks pretty remarkable. As you might expect, the 2.0% net income decline reported by SBS Transit is a bit of a surprise. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

That being said, we compared SBS Transit's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.5% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about SBS Transit's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is SBS Transit Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 50% (that is, a retention ratio of 50%), the fact that SBS Transit's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, SBS Transit has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

In total, it does look like SBS Transit has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for SBS Transit 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.

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