Will Weakness in Connexion Telematics Ltd's (ASX:CXZ) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 18% over the past month, it is easy to disregard Connexion Telematics (ASX:CXZ). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Connexion Telematics' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Connexion Telematics

How To Calculate Return On Equity?

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:

37% = AU$1.8m ÷ AU$4.9m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.37 in profit.

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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Connexion Telematics' Earnings Growth And 37% 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 15% which is quite remarkable. So, the substantial 73% net income growth seen by Connexion Telematics over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Connexion Telematics' growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Connexion Telematics is trading on a high P/E or a low P/E, relative to its industry.

Is Connexion Telematics Efficiently Re-investing Its Profits?

Summary

In total, we are pretty happy with Connexion Telematics' performance. 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. Our risks dashboard would have the 3 risks we have identified for Connexion Telematics.

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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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