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MIND C.T.I's (NASDAQ:MNDO) stock is up by a considerable 16% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to MIND C.T.I's ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for MIND C.T.I is:
30% = US$5.7m ÷ US$19m (Based on the trailing twelve months to March 2021).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.30.
Why Is ROE Important For 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.
MIND C.T.I's Earnings Growth And 30% ROE
To begin with, MIND C.T.I has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. However, for some reason, the higher returns aren't reflected in MIND C.T.I's meagre five year net income growth average of 3.0%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that MIND C.T.I's reported growth was lower than the industry growth of 25% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. 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. 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 MIND C.T.I is trading on a high P/E or a low P/E, relative to its industry.
Is MIND C.T.I Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 96% (or a retention ratio of 3.8%), most of MIND C.T.I's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.
In addition, MIND C.T.I has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Overall, we have mixed feelings about MIND C.T.I. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 2 risks we have identified for MIND C.T.I.
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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