Has RTC Group plc's (LON:RTC) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

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Simply Wall St

Wed, Sep 6, 2023, 11:14 PM 4 min read

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 RTC Group is:

11% = UK£743k ÷ UK£6.9m (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.11 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. 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. 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.

RTC Group's Earnings Growth And 11% ROE

To begin with, RTC Group seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 14%. Further research shows that RTC Group's net income has shrunk at a rate of 44% over the last five years. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. Hence there might be some other aspects that are causing earnings to shrink. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared RTC Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 6.4% over the last few years.

past-earnings-growth — AIM:RTC Past Earnings Growth September 7th 2023

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 RTC Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is RTC Group Using Its Retained Earnings Effectively?

RTC Group's low three-year median payout ratio of 9.7% (implying that it retains the remaining 90% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

In addition, RTC Group has been paying dividends over a period of nine years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

Overall, we feel that RTC Group certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 4 risks we have identified for RTC Group by visiting our risks dashboard for free on our platform here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.