Is Gamma Communications plc's (LON:GAMA) Recent Performance Tethered To Its Attractive Financial Prospects?

Gamma Communications' (LON:GAMA) stock up by 3.5% 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. Particularly, we will be paying attention to Gamma Communications' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Gamma Communications

How Is ROE Calculated?

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 Gamma Communications is:

22% = UK£37m ÷ UK£170m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.22 in profit.

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.

Gamma Communications' Earnings Growth And 22% ROE

Firstly, we acknowledge that Gamma Communications has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. Probably as a result of this, Gamma Communications was able to see a decent net income growth of 20% over the last five years.

We then compared Gamma Communications' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 35% in the same period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Gamma Communications''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Gamma Communications Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 31% (implying that the company retains 69% of its profits), it seems that Gamma Communications is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Gamma Communications has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 24% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

On the whole, we feel that Gamma Communications' 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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