G1 Secure Solutions Ltd's (TLV:GOSS) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

G1 Secure Solutions' (TLV:GOSS) stock up by 8.4% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, 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. In this article, we decided to focus on G1 Secure Solutions' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for G1 Secure Solutions

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 G1 Secure Solutions is:

33% = ₪41m ÷ ₪126m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₪1 of shareholders' capital it has, the company made ₪0.33 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. 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.

G1 Secure Solutions' Earnings Growth And 33% ROE

To begin with, G1 Secure Solutions has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 8.3% also doesn't go unnoticed by us. Despite this, G1 Secure Solutions' five year net income growth was quite low averaging at only 2.5%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then performed a comparison between G1 Secure Solutions' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 2.5% 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 G1 Secure Solutions is trading on a high P/E or a low P/E, relative to its industry.

Is G1 Secure Solutions Making Efficient Use Of Its Profits?

G1 Secure Solutions has a three-year median payout ratio of 62% (implying that it keeps only 38% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, G1 Secure Solutions only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Summary

On the whole, we do feel that G1 Secure Solutions has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. 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. To know the 2 risks we have identified for G1 Secure Solutions visit our risks dashboard for free.

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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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