Kip McGrath Education Centres Limited's (ASX:KME) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Kip McGrath Education Centres (ASX:KME) has had a great run on the share market with its stock up by a significant 10% over the last week. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Kip McGrath Education Centres' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Kip McGrath Education Centres

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 Kip McGrath Education Centres is:

9.4% = AU$1.7m ÷ AU$18m (Based on the trailing twelve months to June 2021).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.09.

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 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 9.4% ROE

At first glance, Kip McGrath Education Centres' ROE doesn't look very promising. However, its ROE is similar to the industry average of 9.7%, so we won't completely dismiss the company. We can see that Kip McGrath Education Centres has grown at a five year net income growth average rate of 4.1%, which is a bit on the lower side. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.

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 17% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Kip McGrath Education Centres is trading on a high P/E or a low P/E, relative to its industry.

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

The high three-year median payout ratio of 60% (that is, the company retains only 40% of its income) over the past three years for Kip McGrath Education Centres suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Moreover, Kip McGrath Education Centres has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Kip McGrath Education Centres. 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. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. Our risks dashboard would have the 2 risks 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.