K2 Internet S.A.'s (WSE:K2I) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

K2 Internet (WSE:K2I) has had a great run on the share market with its stock up by a significant 41% over the last 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 K2 Internet'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for K2 Internet

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 K2 Internet is:

15% = zł4.2m ÷ zł27m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. So, this means that for every PLN1 of its shareholder's investments, the company generates a profit of PLN0.15.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

K2 Internet's Earnings Growth And 15% ROE

At first glance, K2 Internet seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 15%. As you might expect, the 3.5% net income decline reported by K2 Internet is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

That being said, we compared K2 Internet'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 7.1% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is K2 Internet fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is K2 Internet Using Its Retained Earnings Effectively?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.

Conclusion

On the whole, we do feel that K2 Internet 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. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on K2 Internet and see how it has performed in the past by looking at this FREE detailed graph 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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