Are the fundamentals of Silver Lake Resources Limited (ASX:SLR) good enough to warrant a purchase given the stock’s recent weakness?

With its stock down 22% in the past three months, it’s easy to overlook Silver Lake Resources (ASX:SLR). But if you pay close attention, you might find that its leading financial indicators look pretty decent, which could mean the stock could potentially rise in the long run as markets generally reward more resilient long-term fundamentals. In particular, we’ll be paying attention to Silver Lake Resources’ ROE today.

Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

See our latest analysis for Silver Lake Resources

How do you calculate return on equity?

ROE can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Silver Lake Resources is:

7.4% = AU$78 million ÷ AU$1.1 billion (based on trailing 12 months to June 2022).

The “yield” is the profit of the last twelve months. Another way to think about this is that for every 1 Australian dollar of equity, the company was able to make a profit of 0.07 Australian dollars.

Why is ROE important for earnings growth?

So far we have learned that ROE is a measure of a company’s profitability. Based on the share of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate relative to companies that don’t necessarily exhibit these characteristics.

Earnings growth and 7.4% ROE of Silver Lake Resources

At first glance, Silver Lake Resources’ ROE does not look very promising. A quick closer look shows that the company’s ROE also doesn’t compare favorably to the industry average of 17%. Despite this, Silver Lake Resources has been able to grow its bottom line significantly, at a rate of 41% over the past five years. We believe there could be other factors at play here. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio.

We then compared Silver Lake Resources net income growth with the industry and we are pleased to see that the company growth figure is higher compared to the industry which has a growth rate of 27% during the same period.

ASX: SLR Past Earnings Growth September 1, 2022

The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This will help them determine if the future of the title looks bright or ominous. A good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings outlook. So, you might want to check if Silver Lake Resources is trading on a high P/E or a low P/E, relative to its industry.

Does Silver Lake Resources effectively reinvest its profits?

Silver Lake Resources does not pay any dividends to its shareholders, meaning the company has reinvested all of its earnings back into the business. This is probably what explains the strong earnings growth discussed above.

Summary

All in all, it seems that Silver Lake Resources has some positive aspects to its business. With a high reinvestment rate, albeit at a low ROE, the company managed to see considerable growth in earnings. That said, a study of the latest analyst forecasts shows that the company should see a slowdown in future earnings growth. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.

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.

Calculation of discounted cash flows for each share

Simply Wall St performs a detailed calculation of discounted cash flow every 6 hours for every stock in the market, so if you want to find the intrinsic value of any company, just search here. It’s free.