Most readers would already be aware that M.T.I Wireless Edge's (LON:MWE) stock increased significantly by 54% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study M.T.I Wireless Edge's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for M.T.I Wireless Edge

How Is ROE Calculated?

Return on equity 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 M.T.I Wireless Edge is:

14% = US$3.3m ÷ US$24m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.14 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of M.T.I Wireless Edge's Earnings Growth And 14% ROE

At first glance, M.T.I Wireless Edge seems to have a decent ROE. Especially when compared to the industry average of 7.4% the company's ROE looks pretty impressive. This probably laid the ground for M.T.I Wireless Edge's significant 25% net income growth seen over the past five years. However, there could also be other causes 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.

Next, on comparing with the industry net income growth, we found that M.T.I Wireless Edge's reported growth was lower than the industry growth of 33% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is M.T.I Wireless Edge fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is M.T.I Wireless Edge Using Its Retained Earnings Effectively?

M.T.I Wireless Edge has a significant three-year median payout ratio of 58%, meaning the company only retains 42% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, M.T.I Wireless Edge is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 61%.

Conclusion

On the whole, we do feel that M.T.I Wireless Edge has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on M.T.I Wireless Edge and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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