Gale Pacific Limited (ASX:GAP) Stock's On A Decline: Are Poor Fundamentals The Cause?

With its stock down 15% over the past month, it is easy to disregard Gale Pacific (ASX:GAP). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Gale Pacific's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Gale Pacific

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 Gale Pacific is:

4.2% = AU$3.7m ÷ AU$88m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.04.

Why Is ROE Important For Earnings Growth?

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

Gale Pacific's Earnings Growth And 4.2% ROE

On the face of it, Gale Pacific's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 17% either. For this reason, Gale Pacific's five year net income decline of 2.4% 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.

As a next step, we compared Gale Pacific's performance with the industry and found thatGale Pacific's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 1.4% in the same period, which is a slower than the company.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Gale Pacific fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Gale Pacific Making Efficient Use Of Its Profits?

Gale Pacific has a high three-year median payout ratio of 60% (that is, it is retaining 40% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 5 risks we have identified for Gale Pacific by visiting our risks dashboard for free on our platform here.

In addition, Gale Pacific has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Gale Pacific. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Gale Pacific's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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