MicroStrategy’s (NASDAQ:MSTR) stock up by 4.7% over the past month. However, the company’s financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. Specifically, we decided to study MicroStrategy’s ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To 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 MicroStrategy is:
9.3% = US$43m ÷ US$461m (Based on the trailing twelve months to March 2020).
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 $0.09 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
MicroStrategy’s Earnings Growth And 9.3% ROE
On the face of it, MicroStrategy’s ROE is not much to talk about. Next, when compared to the average industry ROE of 12%, the company’s ROE leaves us feeling even less enthusiastic. For this reason, MicroStrategy’s five year net income decline of 30% is not surprising given its lower ROE. 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 MicroStrategy’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 26% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 MicroStrategy’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is MicroStrategy Efficiently Re-investing Its Profits?
MicroStrategy doesn’t pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can’t use them to grow its business. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
On the whole, we feel that the performance shown by MicroStrategy can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 2 risks we have identified for MicroStrategy.
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This article by Simply Wall St is general in nature. 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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