Is Gamma Communications plc's (LON:GAMA) Recent Stock Performance Tethered To Its Strong Fundamentals?
Most readers would already be aware that Gamma Communications' (LON:GAMA) stock increased significantly by 5.4% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Gamma Communications' ROE in this article.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Gamma Communications
How To 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 Gamma Communications is:
16% = UK£52m ÷ UK£323m (Based on the trailing twelve months to June 2023).
The 'return' refers to a company's earnings over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.16.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Gamma Communications' Earnings Growth And 16% ROE
To begin with, Gamma Communications seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 13%. This certainly adds some context to Gamma Communications' decent 14% net income growth seen over the past five years.
Next, on comparing Gamma Communications' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 15% over the last few years.
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. Has the market priced in the future outlook for GAMA? You can find out in our latest intrinsic value infographic research report.
Is Gamma Communications Efficiently Re-investing Its Profits?
In Gamma Communications' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 23% (or a retention ratio of 77%), which suggests that the company is investing most of its profits to grow its business.
Moreover, Gamma Communications is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 23% of its profits over the next three years. As a result, Gamma Communications' ROE is not expected to change by much either, which we inferred from the analyst estimate of 19% for future ROE.
Summary
In total, we are pretty happy with Gamma Communications' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
