Are Kip McGrath Education Centres Limited's (ASX:KME) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 20% over the past three months, it is easy to disregard Kip McGrath Education Centres (ASX:KME). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Kip McGrath Education Centres' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How To 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 Kip McGrath Education Centres is:

12% = AU$2.3m ÷ AU$19m (Based on the trailing twelve months to June 2025).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.12.

View our latest analysis for Kip McGrath Education Centres

What Has ROE Got To Do With 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 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.

Kip McGrath Education Centres' Earnings Growth And 12% ROE

To begin with, Kip McGrath Education Centres seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.5%. Yet, Kip McGrath Education Centres has posted measly growth of 2.6% over the past five years. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Kip McGrath Education Centres' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% 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. Is Kip McGrath Education Centres fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kip McGrath Education Centres Making Efficient Use Of Its Profits?

Kip McGrath Education Centres has a three-year median payout ratio of 63% (implying that it keeps only 37% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Moreover, Kip McGrath Education Centres has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we feel that Kip McGrath Education Centres certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. 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. Our risks dashboard will have the 1 risk we have identified for Kip McGrath Education Centres.

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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.