Yahoo Finance Declining Stock and Solid Fundamentals: Is The Market Wrong About Gamma Communications plc (LON:GAMA)?
It is hard to get excited after looking at Gamma Communications' (LON:GAMA) recent performance, when its stock has declined 6.8% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Gamma Communications' ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Gamma Communications
How Do You 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 Gamma Communications is:
21% = UK£54m ÷ UK£254m (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.21.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Gamma Communications' Earnings Growth And 21% ROE
To begin with, Gamma Communications has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 14% the company's ROE is quite impressive. So, the substantial 27% net income growth seen by Gamma Communications over the past five years isn't overly surprising.
We then performed a comparison between Gamma Communications' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 27% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is GAMA fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Gamma Communications Using Its Retained Earnings Effectively?
The three-year median payout ratio for Gamma Communications is 27%, which is moderately low. The company is retaining the remaining 73%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Gamma Communications is reinvesting its earnings efficiently.
Besides, Gamma Communications has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 22%. Accordingly, forecasts suggest that Gamma Communications' future ROE will be 20% which is again, similar to the current ROE.
Summary
In total, we are pretty happy with Gamma Communications' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
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