Red Violet, Inc.'s (NASDAQ:RDVT) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?
Red Violet's (NASDAQ:RDVT) stock is up by a considerable 16% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Red Violet's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Red Violet
How Is ROE Calculated?
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 Red Violet is:
1.7% = US$1.2m ÷ US$73m (Based on the trailing twelve months to March 2023).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.02 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Red Violet's Earnings Growth And 1.7% ROE
It is hard to argue that Red Violet's ROE is much good in and of itself. Even compared to the average industry ROE of 16%, the company's ROE is quite dismal. Despite this, surprisingly, Red Violet saw an exceptional 50% net income growth over the past five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Red Violet's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 14%.
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. This then helps them determine if the stock is placed for a bright or bleak future. Is Red Violet fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Red Violet Making Efficient Use Of Its Profits?
Given that Red Violet doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
Summary
Overall, we feel that Red Violet certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 1 risk we have identified for Red Violet by visiting our risks dashboard for free on our platform here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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