Are Kip McGrath Education Centres Limited's (ASX:KME) Mixed Financials Driving The Negative Sentiment?

It is hard to get excited after looking at Kip McGrath Education Centres' (ASX:KME) recent performance, when its stock has declined 34% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Kip McGrath Education Centres' ROE today.

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.

Check out our latest analysis for Kip McGrath Education Centres

How To Calculate Return On Equity?

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 Kip McGrath Education Centres is:

8.3% = AU$1.9m ÷ AU$23m (Based on the trailing twelve months to June 2023).

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$0.08.

Why Is ROE Important For 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 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 Kip McGrath Education Centres' Earnings Growth And 8.3% ROE

At first glance, Kip McGrath Education Centres' ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 4.9% which we definitely can't overlook. However, Kip McGrath Education Centres' five year net income decline rate was 9.1%. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared Kip McGrath Education Centres' 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 18% over the last few years.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Kip McGrath Education Centres''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Kip McGrath Education Centres Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 63% (implying that 37% of the profits are retained), most of Kip McGrath Education Centres' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Kip McGrath Education Centres.

Additionally, Kip McGrath Education Centres has paid dividends over a period of nine years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we're a bit ambivalent about Kip McGrath Education Centres' performance. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Kip McGrath Education Centres' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.