Rakon's (NZSE:RAK) stock is up by a considerable 113% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, 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. Specifically, we decided to study Rakon's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Rakon is:
7.3% = NZ$7.3m ÷ NZ$99m (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.07 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 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.
Rakon's Earnings Growth And 7.3% ROE
When you first look at it, Rakon's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. In spite of this, Rakon was able to grow its net income considerably, at a rate of 34% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Rakon's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.9% in the same period.
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. Is Rakon fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Rakon Efficiently Re-investing Its Profits?
On the whole, we do feel that Rakon has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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. Our risks dashboard would have the 2 risks we have identified for Rakon.
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Rakon Limited, together with its subsidiaries, designs, manufactures, and sells frequency control products and timing solutions for various applications in Asia, North America, Europe, and internationally.
Solid track record with excellent balance sheet.