Is Atlas Pearls Limited's (ASX:ATP) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

By
Simply Wall St
Published
January 13, 2022
ASX:ATP
Source: Shutterstock

Atlas Pearls' (ASX:ATP) stock is up by a considerable 48% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Atlas Pearls' 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Atlas Pearls

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 Atlas Pearls is:

36% = AU$6.7m ÷ AU$18m (Based on the trailing twelve months to June 2021).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.36 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Atlas Pearls' Earnings Growth And 36% ROE

To begin with, Atlas Pearls has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 10% also doesn't go unnoticed by us. For this reason, Atlas Pearls' five year net income decline of 38% raises the question as to why the high ROE didn't translate into earnings growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

That being said, we compared Atlas Pearls' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 5.9% in the same period.

past-earnings-growth
ASX:ATP Past Earnings Growth January 13th 2022

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Atlas Pearls is trading on a high P/E or a low P/E, relative to its industry.

Is Atlas Pearls Efficiently Re-investing Its Profits?

Atlas Pearls 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. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Conclusion

In total, it does look like Atlas Pearls has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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 3 risks we have identified for Atlas Pearls visit our risks dashboard for free.

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