Most readers would already be aware that Keywords Studios' (LON:KWS) stock increased significantly by 37% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Keywords Studios' 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 Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Keywords Studios is:
3.9% = €13m ÷ €339m (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.04.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Keywords Studios' Earnings Growth And 3.9% ROE
At first glance, Keywords Studios' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10% either. However, we we're pleasantly surprised to see that Keywords Studios grew its net income at a significant rate of 25% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Keywords Studios' growth is quite high when compared to the industry average growth of 18% in the same period, which is great to see.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Keywords Studios''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Keywords Studios Efficiently Re-investing Its Profits?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.
Our latest analyst data shows that the future payout ratio of the company is expected to drop to 3.2% over the next three years. As a result, the expected drop in Keywords Studios' payout ratio explains the anticipated rise in the company's future ROE to 12%, over the same period.
In total, it does look like Keywords Studios has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
This article by Simply Wall St is general in nature. 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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