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Gear4music (Holdings)'s (LON:G4M) stock is up by a considerable 6.5% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Gear4music (Holdings)'s ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Gear4music (Holdings)
How Is ROE Calculated?
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 Gear4music (Holdings) is:
2.6% = UK£982k ÷ UK£37m (Based on the trailing twelve months to September 2024).
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 £0.03.
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. 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.
Gear4music (Holdings)'s Earnings Growth And 2.6% ROE
It is hard to argue that Gear4music (Holdings)'s ROE is much good in and of itself. Even when compared to the industry average of 9.4%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 55% seen by Gear4music (Holdings) was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
That being said, we compared Gear4music (Holdings)'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 10% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is Gear4music (Holdings) fairly valued compared to other companies? These 3 valuation measures might help you decide.