G8 Education Limited (ASX:GEM) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?
G8 Education (ASX:GEM) has had a great run on the share market with its stock up by a significant 23% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to G8 Education's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for G8 Education
How Is ROE Calculated?
Return on equity 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 G8 Education is:
6.2% = AU$56m ÷ AU$906m (Based on the trailing twelve months to December 2023).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.06 in profit.
What Is The Relationship Between ROE And 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 G8 Education's Earnings Growth And 6.2% ROE
On the face of it, G8 Education's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.4%. Having said that, G8 Education has shown a modest net income growth of 14% over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's 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.
We then compared G8 Education's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 18% in the same 5-year period, which is a bit concerning.
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 G8 Education fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is G8 Education Efficiently Re-investing Its Profits?
While G8 Education has a three-year median payout ratio of 67% (which means it retains 33% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Besides, G8 Education has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 58% of its profits over the next three years. Regardless, the future ROE for G8 Education is predicted to rise to 9.0% despite there being not much change expected in its payout ratio.
Conclusion
On the whole, we feel that the performance shown by G8 Education can be open to many interpretations. While the company has posted a decent earnings growth, We do feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings at a higher rate of return. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
