Tempest Security AB (publ) (STO:TSEC) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

It is hard to get excited after looking at Tempest Security's (STO:TSEC) recent performance, when its stock has declined 15% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Tempest Security's ROE in this article.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Tempest Security

How Do You Calculate Return On Equity?

Return on equity 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 Tempest Security is:

6.0% = kr4.9m ÷ kr82m (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.06 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Tempest Security's Earnings Growth And 6.0% ROE

At first glance, Tempest Security's ROE doesn't look very promising. Next, when compared to the average industry ROE of 9.9%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Tempest Security grew its net income at a significant rate of 63% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared Tempest Security's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 29% in the same 5-year 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Tempest Security is trading on a high P/E or a low P/E, relative to its industry.

Is Tempest Security Making Efficient Use Of Its Profits?

Tempest Security doesn't pay any regular dividends currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

In total, it does look like Tempest Security has some positive aspects to its business. 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. To know the 2 risks we have identified for Tempest Security visit our risks dashboard for free.

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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.