Will Weakness in Covalon Technologies Ltd.'s (CVE:COV) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Covalon Technologies' (CVE:COV) recent performance, when its stock has declined 19% 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 Covalon Technologies' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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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 Covalon Technologies is:

15% = CA$4.7m ÷ CA$31m (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.15 in profit.

See our latest analysis for Covalon Technologies

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Covalon Technologies' Earnings Growth And 15% ROE

To start with, Covalon Technologies' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 17%. Consequently, this likely laid the ground for the impressive net income growth of 32% seen over the past five years by Covalon Technologies. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Covalon Technologies' 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 20%.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Covalon Technologies is trading on a high P/E or a low P/E, relative to its industry.

Is Covalon Technologies Using Its Retained Earnings Effectively?

Covalon Technologies doesn't pay any regular dividends to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Conclusion

In total, we are pretty happy with Covalon Technologies' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. To know the 1 risk we have identified for Covalon Technologies visit our risks dashboard for free.

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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.