Most readers would already be aware that Agromep's (WSE:AGP) stock increased significantly by 20% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Agromep's ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To 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 Agromep is:
16% = zł2.3m ÷ zł14m (Based on the trailing twelve months to September 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each PLN1 of shareholders' capital it has, the company made PLN0.16 in profit.
What Has ROE Got To Do With 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. 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 Agromep's Earnings Growth And 16% ROE
To start with, Agromep's ROE looks acceptable. Be that as it may, the company's ROE is still quite lower than the industry average of 22%. However, we are pleased to see the impressive 37% net income growth reported by Agromep over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. 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. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this also does lend some color to the high earnings growth seen by the company.
We then performed a comparison between Agromep's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 36% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Agromep is trading on a high P/E or a low P/E, relative to its industry.
Is Agromep Making Efficient Use Of Its Profits?
Given that Agromep doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
In total, we are pretty happy with Agromep's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate 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. Our risks dashboard would have the 2 risks we have identified for Agromep.
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.