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Etherstack (ASX:ESK) has had a rough three months with its share price down 26%. 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 Etherstack's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Etherstack
How To Calculate Return On Equity?
ROE 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 Etherstack is:
22% = US$1.5m ÷ US$6.5m (Based on the trailing twelve months to December 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.22 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Etherstack's Earnings Growth And 22% ROE
First thing first, we like that Etherstack has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. Under the circumstances, Etherstack's considerable five year net income growth of 23% was to be expected.
Next, on comparing with the industry net income growth, we found that Etherstack's growth is quite high when compared to the industry average growth of 18% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Etherstack's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.