With its stock down 17% over the past three months, it is easy to disregard AcadeMedia (STO:ACAD). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on AcadeMedia's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 AcadeMedia is:
12% = kr655m ÷ kr5.4b (Based on the trailing twelve months to December 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every SEK1 worth of equity, the company was able to earn SEK0.12 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
AcadeMedia's Earnings Growth And 12% ROE
To begin with, AcadeMedia seems to have a respectable ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 8.8% seen over the past five years by AcadeMedia.
Next, on comparing with the industry net income growth, we found that AcadeMedia's reported growth was lower than the industry growth of 15% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is ACAD worth today? The intrinsic value infographic in our free research report helps visualize whether ACAD is currently mispriced by the market.
Is AcadeMedia Using Its Retained Earnings Effectively?
AcadeMedia has a healthy combination of a moderate three-year median payout ratio of 31% (or a retention ratio of 69%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
While AcadeMedia has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 30% of its profits over the next three years. As a result, AcadeMedia's ROE is not expected to change by much either, which we inferred from the analyst estimate of 12% for future ROE.
In total, we are pretty happy with AcadeMedia's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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.