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Microbix Biosystems (TSE:MBX) has had a rough month with its share price down 4.5%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Microbix Biosystems' ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Microbix Biosystems
How Do You 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 Microbix Biosystems is:
18% = CA$5.1m ÷ CA$28m (Based on the trailing twelve months to June 2024).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.18 in profit.
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 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 Microbix Biosystems' Earnings Growth And 18% ROE
To begin with, Microbix Biosystems seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 18%. Consequently, this likely laid the ground for the impressive net income growth of 49% seen over the past five years by Microbix Biosystems. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Microbix Biosystems' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 21% in the same 5-year 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. One 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 prospects. So, you may want to check if Microbix Biosystems is trading on a high P/E or a low P/E, relative to its industry.