Codeaddict (WSE:CDT) has had a rough three months with its share price down 23%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Codeaddict's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Codeaddict is:
1.3% = zł60k ÷ zł4.8m (Based on the trailing twelve months to March 2021).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each PLN1 of shareholders' capital it has, the company made PLN0.01 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Codeaddict's Earnings Growth And 1.3% ROE
It is quite clear that Codeaddict's ROE is rather low. Even when compared to the industry average of 16%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 41% seen by Codeaddict over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
That being said, we compared Codeaddict's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 2.3% 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). This then helps them determine if the stock is placed for a bright or bleak future. Is Codeaddict fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Codeaddict Using Its Retained Earnings Effectively?
Overall, we have mixed feelings about Codeaddict. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 5 risks we have identified for Codeaddict visit our risks dashboard for free.
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