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Is Weakness In Educational Development Corporation (NASDAQ:EDUC) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

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Educational Development (NASDAQ:EDUC) has had a rough three months with its share price down 42%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Educational Development's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Educational Development

How To 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 Educational Development is:

18% = US$8.3m ÷ US$47m (Based on the trailing twelve months to February 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Educational Development's Earnings Growth And 18% ROE

At first glance, Educational Development seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 19%. This certainly adds some context to Educational Development's exceptional 23% net income growth seen over the past five years. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Educational Development's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 23% in the same period.

past-earnings-growth
past-earnings-growth

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. 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 Educational Development's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Educational Development Making Efficient Use Of Its Profits?

The three-year median payout ratio for Educational Development is 28%, which is moderately low. The company is retaining the remaining 72%. By the looks of it, the dividend is well covered and Educational Development is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Educational Development has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we feel that Educational Development's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 6 risks we have identified for Educational Development 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.