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G8 Education's (ASX:GEM) stock is up by a considerable 18% over the past three months. 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 G8 Education's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for G8 Education
How Do You 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 G8 Education is:
6.2% = AU$56m ÷ AU$906m (Based on the trailing twelve months to December 2023).
The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 G8 Education's Earnings Growth And 6.2% ROE
On the face of it, G8 Education's ROE is not much to talk about. However, its ROE is similar to the industry average of 6.2%, so we won't completely dismiss the company. Having said that, G8 Education has shown a modest net income growth of 14% over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.
We then performed a comparison between G8 Education's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 14% in the same 5-year period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 G8 Education is trading on a high P/E or a low P/E, relative to its industry.