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With its stock down 34% over the past three months, it is easy to disregard United-Guardian (NASDAQ:UG). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on United-Guardian's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for United-Guardian
How To Calculate Return On Equity?
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 United-Guardian is:
31% = US$3.5m ÷ US$11m (Based on the trailing twelve months to September 2024).
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 $0.31 in profit.
What Is The Relationship Between ROE And 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.
United-Guardian's Earnings Growth And 31% ROE
To begin with, United-Guardian has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. As you might expect, the 10% net income decline reported by United-Guardian doesn't bode well with us. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared United-Guardian'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 9.3% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 United-Guardian is trading on a high P/E or a low P/E, relative to its industry.