Is Instem plc's (LON:INS) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

Instem's (LON:INS) stock is up by a considerable 15% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Instem's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Instem

How Do You 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 Instem is:

2.0% = UK£339k ÷ UK£17m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.02 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. 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 Instem's Earnings Growth And 2.0% ROE

It is hard to argue that Instem's ROE is much good in and of itself. Even compared to the average industry ROE of 12%, the company's ROE is quite dismal. Instem was still able to see a decent net income growth of 13% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing Instem's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 13% in the same period.

Earnings growth is a huge factor in stock valuation. 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. 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 Instem is trading on a high P/E or a low P/E, relative to its industry.

Is Instem Using Its Retained Earnings Effectively?

Summary

On the whole, we do feel that Instem 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 3 risks we have identified for Instem.

If you’re looking to trade Instem, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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