With its stock down 11% over the past three months, it is easy to disregard CMS Edu (KOSDAQ:225330). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study CMS Edu's ROE in this article.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for CMS Edu is:
14% = ₩5.7b ÷ ₩41b (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₩1 worth of equity, the company was able to earn ₩0.14 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of CMS Edu's Earnings Growth And 14% ROE
At first glance, CMS Edu seems to have a decent ROE. Especially when compared to the industry average of 8.2% the company's ROE looks pretty impressive. For this reason, CMS Edu's five year net income decline of 6.9% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared CMS Edu's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 10.0% in the same period. This is quite worrisome.
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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about CMS Edu's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is CMS Edu Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 78% (implying that 22% of the profits are retained), most of CMS Edu's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 4 risks we have identified for CMS Edu.
In addition, CMS Edu only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.
On the whole, we do feel that CMS Edu has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into CMS Edu's past profit growth, check out this visualization of past earnings, revenue and cash flows.
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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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