Can Kip McGrath Education Centres Limited's (ASX:KME) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?
Kip McGrath Education Centres' (ASX:KME) stock is up by a considerable 31% over the past month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Kip McGrath Education Centres' ROE.
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 Kip McGrath Education Centres
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 Kip McGrath Education Centres is:
7.3% = AU$1.6m ÷ AU$22m (Based on the trailing twelve months to December 2022).
The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.07 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Kip McGrath Education Centres' Earnings Growth And 7.3% ROE
On the face of it, Kip McGrath Education Centres' ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 7.3%, we may spare it some thought. But Kip McGrath Education Centres saw a five year net income decline of 7.1% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.
However, when we compared Kip McGrath Education Centres' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Kip McGrath Education Centres''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Kip McGrath Education Centres Efficiently Re-investing Its Profits?
Kip McGrath Education Centres' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 59% (or a retention ratio of 41%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 3 risks we have identified for Kip McGrath Education Centres by visiting our risks dashboard for free on our platform here.
Additionally, Kip McGrath Education Centres has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.
Conclusion
Overall, we would be extremely cautious before making any decision on Kip McGrath Education Centres. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Up till now, we've only made a short study of the company's growth data. To gain further insights into Kip McGrath Education Centres' past profit growth, check out this visualization of past earnings, revenue and cash flows.
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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.
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