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Could The Market Be Wrong About Gullewa Limited (ASX:GUL) Given Its Attractive Financial Prospects?

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·3 min read
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It is hard to get excited after looking at Gullewa's (ASX:GUL) recent performance, when its stock has declined 8.1% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Gullewa's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Gullewa

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 Gullewa is:

16% = AU$2.4m ÷ AU$15m (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.16.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Gullewa's Earnings Growth And 16% ROE

To start with, Gullewa's ROE looks acceptable. Even when compared to the industry average of 16% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 47% seen over the past five years by Gullewa. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Gullewa's growth is quite high when compared to the industry average growth of 26% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Gullewa's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Gullewa Making Efficient Use Of Its Profits?

Gullewa doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

On the whole, we feel that Gullewa's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 4 risks we have identified for Gullewa by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.