Gear4music (Holdings) plc's (LON:G4M) Stock Is Going Strong: Is the Market Following Fundamentals?

Gear4music (Holdings) (LON:G4M) has had a great run on the share market with its stock up by a significant 34% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Gear4music (Holdings)'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.

Check out our latest analysis for Gear4music (Holdings)

How Is ROE Calculated?

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 Gear4music (Holdings) is:

29% = UK£7.7m ÷ UK£27m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.29.

Why Is ROE Important For 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 Gear4music (Holdings)'s Earnings Growth And 29% ROE

First thing first, we like that Gear4music (Holdings) has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. So, the substantial 49% net income growth seen by Gear4music (Holdings) over the past five years isn't overly surprising.

Given that the industry shrunk its earnings at a rate of 1.9% in the same period, the net income growth of the company is quite impressive.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Gear4music (Holdings)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Gear4music (Holdings) Using Its Retained Earnings Effectively?

Conclusion

Overall, we are quite pleased with Gear4music (Holdings)'s 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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