Are Poor Financial Prospects Dragging Down Warpaint London PLC (LON:W7L Stock?
It is hard to get excited after looking at Warpaint London's (LON:W7L) recent performance, when its stock has declined 9.4% over the past month. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Warpaint London's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Warpaint London
How Do You Calculate Return On Equity?
ROE 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 Warpaint London is:
1.2% = UK£419k ÷ UK£35m (Based on the trailing twelve months to June 2021).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.01 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Warpaint London's Earnings Growth And 1.2% ROE
As you can see, Warpaint London's ROE looks pretty weak. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 40% seen by Warpaint London was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared Warpaint London's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 18% in the same period.
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. If you're wondering about Warpaint London's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Warpaint London Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 94% (implying that 5.5% of the profits are retained), most of Warpaint London's profits are being paid to shareholders, which explains the company's shrinking earnings. 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. Our risks dashboard should have the 3 risks we have identified for Warpaint London.
Additionally, Warpaint London has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 83%.
Conclusion
In total, we would have a hard think before deciding on any investment action concerning Warpaint London. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Warpaint London 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. 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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