G5 Entertainment AB (publ)'s (STO:G5EN) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at G5 Entertainment's (STO:G5EN) recent performance, when its stock has declined 23% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to G5 Entertainment's ROE today.

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.

View our latest analysis for G5 Entertainment

How Do You 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 G5 Entertainment is:

45% = kr190m ÷ kr426m (Based on the trailing twelve months to September 2021).

The 'return' is the income the business earned over the last year. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.45.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

G5 Entertainment's Earnings Growth And 45% ROE

To begin with, G5 Entertainment has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 6.7% which is quite remarkable. So, the substantial 21% net income growth seen by G5 Entertainment over the past five years isn't overly surprising.

As a next step, we compared G5 Entertainment's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 12%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 G5 Entertainment is trading on a high P/E or a low P/E, relative to its industry.

Is G5 Entertainment Making Efficient Use Of Its Profits?

G5 Entertainment has a three-year median payout ratio of 28% (where it is retaining 72% of its income) which is not too low or not too high. So it seems that G5 Entertainment is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, G5 Entertainment has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 24%. However, G5 Entertainment's future ROE is expected to decline to 34% despite there being not much change anticipated in the company's payout ratio.

Summary

On the whole, we feel that G5 Entertainment's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.