Is Weakness In Paradox Interactive AB (publ) (STO:PDX) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 20% over the past three months, it is easy to disregard Paradox Interactive (STO:PDX). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Paradox Interactive's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Paradox Interactive

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 Paradox Interactive is:

25% = kr627m ÷ kr2.5b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.25 in profit.

Why Is ROE Important For 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. 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.

Paradox Interactive's Earnings Growth And 25% ROE

First thing first, we like that Paradox Interactive has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 2.8% also doesn't go unnoticed by us. This likely paved the way for the modest 14% net income growth seen by Paradox Interactive over the past five years.

We then compared Paradox Interactive's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 26% in the same 5-year period, which is a bit concerning.

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. If you're wondering about Paradox Interactive's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Paradox Interactive Using Its Retained Earnings Effectively?

Paradox Interactive has a three-year median payout ratio of 29%, which implies that it retains the remaining 71% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Paradox Interactive is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 27% of its profits over the next three years. Accordingly, forecasts suggest that Paradox Interactive's future ROE will be 26% which is again, similar to the current ROE.

Summary

On the whole, we feel that Paradox Interactive's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.