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Declining Stock and Solid Fundamentals: Is The Market Wrong About Geodrill Limited (TSE:GEO)?

It is hard to get excited after looking at Geodrill's (TSE:GEO) recent performance, when its stock has declined 15% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Geodrill'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Geodrill

How Do You 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 Geodrill is:

16% = US$14m ÷ US$83m (Based on the trailing twelve months to June 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.16 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

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

At first glance, Geodrill seems to have a decent ROE. Even when compared to the industry average of 16% the company's ROE looks quite decent. This probably goes some way in explaining Geodrill's moderate 15% growth over the past five years amongst other factors.

We then compared Geodrill's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 29% in the same period, which is a bit concerning.

past-earnings-growth
past-earnings-growth

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 Geodrill fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Geodrill Efficiently Re-investing Its Profits?

In Geodrill's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 4.0% (or a retention ratio of 96%), which suggests that the company is investing most of its profits to grow its business.

Conclusion

In total, we are pretty happy with Geodrill's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard would have the 3 risks we have identified for Geodrill.

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.

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

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