CPU Softwarehouse (FRA:CPU2) has had a rough three months with its share price down 8.8%. 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 CPU Softwarehouse's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You 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 CPU Softwarehouse is:
32% = €455k ÷ €1.4m (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.32.
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. 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. 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 CPU Softwarehouse's Earnings Growth And 32% ROE
To begin with, CPU Softwarehouse has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. Under the circumstances, CPU Softwarehouse's considerable five year net income growth of 66% was to be expected.
We then compared CPU Softwarehouse's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 7.9% 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about CPU Softwarehouse's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is CPU Softwarehouse Making Efficient Use Of Its Profits?
CPU Softwarehouse doesn't pay any dividend 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.
Overall, we are quite pleased with CPU Softwarehouse's 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for CPU Softwarehouse by visiting our risks dashboard for free on our platform here.
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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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