With its stock down 15% over the past month, it is easy to disregard 3P Learning (ASX:3PL). 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 3P Learning'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 3P Learning is:
8.8% = AU$2.0m ÷ AU$23m (Based on the trailing twelve months to December 2019).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.09.
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.
A Side By Side comparison of 3P Learning's Earnings Growth And 8.8% ROE
At first glance, 3P Learning's ROE doesn't look very promising. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. For this reason, 3P Learning's five year net income decline of 31% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared 3P Learning'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 21% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is 3P Learning fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is 3P Learning Efficiently Re-investing Its Profits?
3P Learning doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Overall, we have mixed feelings about 3P Learning. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for 3P Learning visit our risks dashboard for free.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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