Declining Stock and Decent Financials: Is The Market Wrong About Pacte Novation (EPA:MLPAC)?

It is hard to get excited after looking at Pacte Novation's (EPA:MLPAC) recent performance, when its stock has declined 34% over the past week. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Pacte Novation'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.

See our latest analysis for Pacte Novation

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 Pacte Novation is:

4.2% = €89k ÷ €2.1m (Based on the trailing twelve months to March 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.04.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Pacte Novation's Earnings Growth And 4.2% ROE

At first glance, Pacte Novation's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.8% either. In spite of this, Pacte Novation was able to grow its net income considerably, at a rate of 24% in the last five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Pacte Novation's growth is quite high when compared to the industry average growth of 8.0% 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 Pacte Novation is trading on a high P/E or a low P/E, relative to its industry.

Is Pacte Novation Making Efficient Use Of Its Profits?

Summary

On the whole, we do feel that Pacte Novation has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 4 risks we have identified for Pacte Novation.

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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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