Precise Biometrics (STO:PREC) has had a great run on the share market with its stock up by a significant 22% over the last month. 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 Precise Biometrics' ROE today.
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. 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?
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 Precise Biometrics is:
0.8% = kr1.0m ÷ kr126m (Based on the trailing twelve months to December 2019).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every SEK1 worth of equity, the company was able to earn SEK0.01 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Precise Biometrics' Earnings Growth And 0.8% ROE
It is quite clear that Precise Biometrics' ROE is rather low. Not just that, even compared to the industry average of 11%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 2.0% seen by Precise Biometrics over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.
So, as a next step, we compared Precise Biometrics' 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.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Precise Biometrics fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Precise Biometrics Efficiently Re-investing Its Profits?
Because Precise Biometrics doesn't pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In total, we're a bit ambivalent about Precise Biometrics' performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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