SIA Engineering (SGX:S59) has had a rough three months with its share price down 2.1%. 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 decided to focus on SIA Engineering's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for SIA Engineering

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for SIA Engineering is:

6.1% = S$103m ÷ S$1.7b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.06.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

SIA Engineering's Earnings Growth And 6.1% ROE

When you first look at it, SIA Engineering's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 8.3%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 15% seen by SIA Engineering over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

So, as a next step, we compared SIA Engineering's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.3% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for S59? You can find out in our latest intrinsic value infographic research report.

Is SIA Engineering Efficiently Re-investing Its Profits?

SIA Engineering has a high three-year median payout ratio of 92% (that is, it is retaining 7.5% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, SIA Engineering 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 73% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 9.4%, over the same period.

Conclusion

On the whole, SIA Engineering's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.