Ergomed (LON:ERGO) has had a rough month with its share price down 13%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Ergomed’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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
Return on equity 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 Ergomed is:
20% = UK£12m ÷ UK£59m (Based on the trailing twelve months to June 2021).
The ‘return’ is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.20 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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.
Ergomed’s Earnings Growth And 20% ROE
To start with, Ergomed’s ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 18%. This probably goes some way in explaining Ergomed’s significant 49% net income growth over the past five years amongst other factors. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then performed a comparison between Ergomed’s net income growth with the industry, which revealed that the company’s growth is similar to the average industry growth of 49% in the same period.
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. Doing so will help them establish if the stock’s future looks promising or ominous. Is ERGO fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is Ergomed Efficiently Re-investing Its Profits?
Ergomed doesn’t pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what’s driving the high earnings growth number discussed above.
On the whole, we feel that Ergomed’s performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.