Klassik Radio AG's (ETR:KA8) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Most readers would already be aware that Klassik Radio's (ETR:KA8) stock increased significantly by 10% over the past week. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Klassik Radio's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Klassik Radio

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 Klassik Radio is:

8.3% = €579k ÷ €6.9m (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.08 in profit.

What Has ROE Got To Do With 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 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.

Klassik Radio's Earnings Growth And 8.3% ROE

When you first look at it, Klassik Radio's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 6.8%, is definitely interesting. However, Klassik Radio's five year net income decline rate was 19%. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to shrink.

However, when we compared Klassik Radio's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 1.1% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Klassik Radio's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Klassik Radio Using Its Retained Earnings Effectively?

With a three-year median payout ratio as high as 119%,Klassik Radio's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Its usually very hard to sustain dividend payments that are higher than reported profits. You can see the 3 risks we have identified for Klassik Radio by visiting our risks dashboard for free on our platform here.

Moreover, Klassik Radio has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Klassik Radio. While its ROE is pretty moderate, the company is retaining very little of its profits, meaning very little of its profits are being reinvested into the business. This explains the lack or absence of growth in its earnings. Up till now, we've only made a short study of the company's growth data. To gain further insights into Klassik Radio's past profit growth, check out this visualization of past earnings, revenue and cash flows.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.