Is Grand Gulf Energy Limited's(ASX:GGE) Recent Stock Performance Tethered To Its Strong Fundamentals?

Grand Gulf Energy's (ASX:GGE) stock is up by a considerable 50% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Grand Gulf Energy's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Grand Gulf Energy

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 Grand Gulf Energy is:

12% = AU$325k ÷ AU$2.8m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.12 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Grand Gulf Energy's Earnings Growth And 12% ROE

At first glance, Grand Gulf Energy seems to have a decent ROE. On comparing with the average industry ROE of 9.6% the company's ROE looks pretty remarkable. This probably laid the ground for Grand Gulf Energy's significant 50% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing Grand Gulf Energy's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 49% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Grand Gulf Energy is trading on a high P/E or a low P/E, relative to its industry.

Is Grand Gulf Energy Making Efficient Use Of Its Profits?

Conclusion

In total, we are pretty happy with Grand Gulf Energy's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 3 risks we have identified for Grand Gulf Energy visit our risks dashboard for free.

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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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