Kip McGrath Education Centres Limited's (ASX:KME) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Kip McGrath Education Centres' (ASX:KME) stock is up by a considerable 17% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Kip McGrath Education Centres' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View 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:

8.8% = AU$1.6m ÷ AU$18m (Based on the trailing twelve months to June 2020).

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.

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 8.8% ROE

When you first look at it, Kip McGrath Education Centres' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 9.1%, we may spare it some thought. Even so, Kip McGrath Education Centres has shown a fairly decent growth in its net income which grew at a rate of 18%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Kip McGrath Education Centres' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 18% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 61% (or a retention ratio of 39%) for Kip McGrath Education Centres suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Kip McGrath Education Centres has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

Overall, we feel that Kip McGrath Education Centres certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. 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. 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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