RM plc's (LON:RM.) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Most readers would already be aware that RM's (LON:RM.) stock increased significantly by 19% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study RM'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for RM

How Is ROE Calculated?

ROE 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 RM is:

29% = UK£14m ÷ UK£47m (Based on the trailing twelve months to May 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.29 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 RM's Earnings Growth And 29% ROE

First thing first, we like that RM has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 8.3% also doesn't go unnoticed by us. This probably laid the groundwork for RM's moderate 7.0% net income growth seen over the past five years.

As a next step, we compared RM's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 12% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about RM's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is RM Efficiently Re-investing Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 30%. Regardless, RM's ROE is speculated to decline to 21% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that RM's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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