Cyanotech Corporation's (NASDAQ:CYAN) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Most readers would already be aware that Cyanotech's (NASDAQ:CYAN) stock increased significantly by 13% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Cyanotech's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 Cyanotech
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Cyanotech is:
3.6% = US$585k ÷ US$16m (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.04 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Cyanotech's Earnings Growth And 3.6% ROE
It is hard to argue that Cyanotech's ROE is much good in and of itself. Even compared to the average industry ROE of 16%, the company's ROE is quite dismal. However, we we're pleasantly surprised to see that Cyanotech grew its net income at a significant rate of 23% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Cyanotech's growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.
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. This then helps them determine if the stock is placed for a bright or bleak future. Is Cyanotech fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Cyanotech Using Its Retained Earnings Effectively?
Summary
On the whole, we do feel that Cyanotech has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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. To know the 2 risks we have identified for Cyanotech visit our risks dashboard for free.
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. 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.
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