Connexion Telematics Ltd's (ASX:CXZ) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Connexion Telematics' (ASX:CXZ) recent performance, when its stock has declined 17% over the past three months. 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 Connexion Telematics' ROE today.

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.

Check out our latest analysis for Connexion Telematics

How Is ROE Calculated?

Return on equity 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 Connexion Telematics is:

66% = AU$3.2m ÷ AU$4.8m (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.66 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Connexion Telematics' Earnings Growth And 66% ROE

Firstly, we acknowledge that Connexion Telematics has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. So, the substantial 65% net income growth seen by Connexion Telematics over the past five years isn't overly surprising.

As a next step, we compared Connexion Telematics' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Connexion Telematics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Connexion Telematics Efficiently Re-investing Its Profits?

Conclusion

In total, we are pretty happy with Connexion Telematics' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Connexion Telematics 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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