Is Weakness In GMO AD Partners Inc. (TYO:4784) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 19% over the past three months, it is easy to disregard GMO AD Partners (TYO:4784). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on GMO AD Partners' ROE.

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.

View our latest analysis for GMO AD Partners

How To Calculate Return On Equity?

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 GMO AD Partners is:

8.5% = JP¥459m ÷ JP¥5.4b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every ¥1 of its shareholder's investments, the company generates a profit of ¥0.08.

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. 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.

GMO AD Partners' Earnings Growth And 8.5% ROE

At first glance, GMO AD Partners seems to have a decent ROE. Even when compared to the industry average of 7.3% the company's ROE looks quite decent. This probably goes some way in explaining GMO AD Partners' significant 48% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared GMO AD Partners' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.2%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about GMO AD Partners''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is GMO AD Partners Making Efficient Use Of Its Profits?

The three-year median payout ratio for GMO AD Partners is 43%, which is moderately low. The company is retaining the remaining 57%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like GMO AD Partners is reinvesting its earnings efficiently.

Moreover, GMO AD Partners is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

Overall, we are quite pleased with GMO AD Partners' 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 3 risks we have identified for GMO AD Partners 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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