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Gear4music (Holdings)'s (LON:G4M) stock up by 6.4% over the past three months. Since the market usually pay for a company’s long-term financial health, we decided to study the company’s fundamentals to see if they could be influencing the market. Specifically, we decided to study Gear4music (Holdings)'s ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
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 Gear4music (Holdings) is:
29% = UK£7.7m ÷ UK£27m (Based on the trailing twelve months to September 2020).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.29 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
Gear4music (Holdings)'s Earnings Growth And 29% ROE
To begin with, Gear4music (Holdings) has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. Under the circumstances, Gear4music (Holdings)'s considerable five year net income growth of 49% was to be expected.
Next, on comparing with the industry net income growth, we found that the growth figure reported by Gear4music (Holdings) compares quite favourably to the industry average, which shows a decline of 2.7% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Gear4music (Holdings) is trading on a high P/E or a low P/E, relative to its industry.
Is Gear4music (Holdings) Making Efficient Use Of Its Profits?
Overall, we are quite pleased with Gear4music (Holdings)'s performance. 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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