GEM Services, Inc.'s (TPE:6525) Stock Is Going Strong: Have Financials A Role To Play?

GEM Services (TPE:6525) has had a great run on the share market with its stock up by a significant 26% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to GEM Services' ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for GEM Services

How Do You 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 GEM Services is:

18% = NT$658m ÷ NT$3.7b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.18 in profit.

What Is The Relationship Between ROE And 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. 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.

GEM Services' Earnings Growth And 18% ROE

At first glance, GEM Services seems to have a decent ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Probably as a result of this, GEM Services was able to see a decent growth of 6.9% over the last five years.

We then compared GEM Services' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 9.0% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 GEM Services is trading on a high P/E or a low P/E, relative to its industry.

Is GEM Services Efficiently Re-investing Its Profits?

GEM Services has a significant three-year median payout ratio of 61%, meaning that it is left with only 39% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Additionally, GEM Services has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

In total, it does look like GEM Services has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. Up till now, we've only made a short study of the company's growth data. To gain further insights into GEM Services' past profit growth, check out this visualization 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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