Has Kip McGrath Education Centres Limited's (ASX:KME) Impressive Stock Performance Got Anything to Do With Its Fundamentals?
Kip McGrath Education Centres' (ASX:KME) stock is up by a considerable 17% 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. Specifically, we decided to study Kip McGrath Education Centres' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Kip McGrath Education Centres
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 Kip McGrath Education Centres is:
8.8% = AU$1.6m ÷ AU$18m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.09 in profit.
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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of Kip McGrath Education Centres' Earnings Growth And 8.8% ROE
At first glance, Kip McGrath Education Centres' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.1%. On the other hand, Kip McGrath Education Centres reported a moderate 18% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some 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.
We then performed a comparison between Kip McGrath Education Centres' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 18% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Kip McGrath Education Centres is trading on a high P/E or a low P/E, relative to its industry.
Is Kip McGrath Education Centres Making Efficient Use Of Its Profits?
Kip McGrath Education Centres has a significant three-year median payout ratio of 61%, meaning that it is left with only 39% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Besides, Kip McGrath Education Centres has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders.
Summary
In total, it does look like Kip McGrath Education Centres has some positive aspects to its business. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Kip McGrath Education Centres and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
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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