With its stock down 17% over the past three months, it is easy to disregard Lingo Media (CVE:LM). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Lingo Media's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Lingo Media is:
66% = CA$889k ÷ CA$1.3m (Based on the trailing twelve months to September 2020).
The 'return' refers to a company's earnings over the last year. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.66 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. 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 Lingo Media's Earnings Growth And 66% ROE
To begin with, Lingo Media has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. As you might expect, the 19% net income decline reported by Lingo Media doesn't bode well with us. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared Lingo Media's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 20% in the same period.
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. Is Lingo Media fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Lingo Media Efficiently Re-investing Its Profits?
In total, it does look like Lingo Media has some positive aspects to its business. 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. Our risks dashboard would have the 3 risks we have identified for Lingo Media.
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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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