Declining Stock and Solid Fundamentals: Is The Market Wrong About Gullewa Limited (ASX:GUL)?

With its stock down 15% over the past three months, it is easy to disregard Gullewa (ASX:GUL). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Gullewa's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 Gullewa

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Gullewa is:

11% = AU$1.4m ÷ AU$13m (Based on the trailing twelve months to June 2021).

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$0.11 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Gullewa's Earnings Growth And 11% ROE

At first glance, Gullewa seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 13%. This certainly adds some context to Gullewa's exceptional 60% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Gullewa's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 24% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Gullewa fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Gullewa Using Its Retained Earnings Effectively?

Given that Gullewa doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

On the whole, we feel that Gullewa's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. You can see the 5 risks we have identified for Gullewa by visiting our risks dashboard for free on our platform here.

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.

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