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Most readers would already be aware that Etherstack's (ASX:ESK) stock increased significantly by 56% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Etherstack's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Etherstack
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 Etherstack is:
2.2% = US$186k ÷ US$8.4m (Based on the trailing twelve months to June 2024).
The 'return' refers to a company's earnings 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$0.02 in profit.
What Is The Relationship Between ROE And 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 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 Etherstack's Earnings Growth And 2.2% ROE
It is quite clear that Etherstack's ROE is rather low. Even compared to the average industry ROE of 8.0%, the company's ROE is quite dismal. In spite of this, Etherstack was able to grow its net income considerably, at a rate of 38% in the last five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
We then compared Etherstack's 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. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Etherstack's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.