Euromoney Institutional Investor's (LON:ERM) stock is up by a considerable 15% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. In this article, we decided to focus on Euromoney Institutional Investor's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Euromoney Institutional Investor
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 Euromoney Institutional Investor is:
5.9% = UK£31m ÷ UK£517m (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.06.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Euromoney Institutional Investor's Earnings Growth And 5.9% ROE
At first glance, Euromoney Institutional Investor's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.9%, so we won't completely dismiss the company. But Euromoney Institutional Investor saw a five year net income decline of 11% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.
That being said, we compared Euromoney Institutional Investor's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.9% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is ERM fairly valued? This infographic on the company's intrinsic value has everything you need to know.