Is Adacel Technologies Limited's (ASX:ADA) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

Most readers would already be aware that Adacel Technologies' (ASX:ADA) stock increased significantly by 36% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Adacel Technologies' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Adacel Technologies

How Is ROE Calculated?

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 Adacel Technologies is:

24% = AU$3.6m ÷ AU$15m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.24 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Adacel Technologies' Earnings Growth And 24% ROE

To begin with, Adacel Technologies has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. Needless to say, we are quite surprised to see that Adacel Technologies' net income shrunk at a rate of 29% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

So, as a next step, we compared Adacel Technologies' 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 11% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Adacel Technologies fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Adacel Technologies Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 41% (where it is retaining 59% of its profits), Adacel Technologies has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Adacel Technologies has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 79% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we feel that Adacel Technologies certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 4 risks we have identified for Adacel Technologies 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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