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Kip McGrath Education Centres (ASX:KME) has had a rough three months with its share price down 20%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to Kip McGrath Education Centres' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Kip McGrath Education Centres is:
9.4% = AU$1.7m ÷ AU$18m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.09 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Kip McGrath Education Centres' Earnings Growth And 9.4% ROE
When you first look at it, Kip McGrath Education Centres' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 10%. On the other hand, Kip McGrath Education Centres reported a fairly low 4.1% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.
We then compared Kip McGrath Education Centres' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. 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 Kip McGrath Education Centres fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Kip McGrath Education Centres Making Efficient Use Of Its Profits?
Kip McGrath Education Centres has a three-year median payout ratio of 60% (implying that it keeps only 40% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.
In addition, Kip McGrath Education Centres has been paying dividends over a period of seven years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
In total, we would have a hard think before deciding on any investment action concerning Kip McGrath Education Centres. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. Our risks dashboard would have the 3 risks we have identified for Kip McGrath Education Centres.
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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