Could The Market Be Wrong About Extreme Co.,Ltd. (TSE:6033) Given Its Attractive Financial Prospects?

With its stock down 20% over the past three months, it is easy to disregard ExtremeLtd (TSE:6033). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study ExtremeLtd'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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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 ExtremeLtd is:

20% = JP¥1.2b ÷ JP¥6.0b (Based on the trailing twelve months to December 2024).

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 ¥0.20.

View our latest analysis for ExtremeLtd

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of ExtremeLtd's Earnings Growth And 20% ROE

To begin with, ExtremeLtd seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.5%. This certainly adds some context to ExtremeLtd's decent 8.0% net income growth seen over the past five years.

As a next step, we compared ExtremeLtd'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 10.0% in the same period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ExtremeLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is ExtremeLtd Efficiently Re-investing Its Profits?

In ExtremeLtd's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 18% (or a retention ratio of 82%), which suggests that the company is investing most of its profits to grow its business.

Besides, ExtremeLtd has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders.

Summary

On the whole, we feel that ExtremeLtd's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 2 risks we have identified for ExtremeLtd visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.