It’s hard to get excited after watching the recent performance of Sapiens International (NASDAQ:SPNS), as its stock is down 21% in the past three months. But if you pay close attention, you might realize that its strong financials could mean the stock could potentially see a long-term rise in value, as the markets generally reward companies in good financial shape. More specifically, we decided to study Sapiens International RE in this article.
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In simple terms, it is used to assess the profitability of a company in relation to its equity.
How is ROE calculated?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Sapiens International is:
11% = $42 million ÷ $391 million (based on trailing 12 months to September 2021).
“Yield” is the income the business has earned over the past year. Another way to think about this is that for every dollar of equity, the company was able to make $0.11 in profit.
What is the relationship between ROE and earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. We now need to assess how much profit the company is reinvesting or “retaining” for future growth, which then gives us an idea of the company’s growth potential. 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.
Earnings growth and ROE of 11% from Sapiens International
For starters, Sapiens International’s ROE seems acceptable. And comparing with the industry, we found that the industry average ROE is similar at 11%. Therefore, this likely laid the foundation for the impressive 33% net income growth seen over the past five years by Sapiens International. However, there could also be other drivers behind this growth. Such as – high revenue retention or effective management in place.
We then compared the growth of net income of Sapiens International with the industry and we are happy to see that the growth figure of the company is higher compared to the industry which has a growth rate of 20% in during the same period.
Earnings growth is an important factor in stock valuation. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This then helps them determine if the stock is positioned for a bright or bleak future. Has the market priced in the future prospects of SPNS? You can find out in our latest intrinsic value infographic research report.
Does Sapiens International effectively reinvest its profits?
Sapiens International has a three-year median payout ratio of 36% (where it keeps 64% of its revenue), which is neither too low nor too high. This suggests that its dividend is well covered, and given the strong growth we discussed above, it appears that Sapiens International is reinvesting its earnings effectively.
While Sapiens International has been increasing its profits, it only recently started paying dividends, which likely means the company has decided to impress new and existing shareholders with a dividend. After reviewing the latest analyst consensus data, we found that the company is expected to continue to pay out about 31% of its earnings over the next three years. Either way, Sapiens International’s future ROE is expected to reach 15% despite little change expected in its payout ratio.
Overall, we are quite satisfied with the performance of Sapiens International. In particular, it is good to see that the company is investing heavily in its business, and together with a high rate of return, this has led to significant growth in its profits. That said, the latest forecasts from industry analysts show that the company’s earnings growth is expected to slow. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.
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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.