Groundhog Inc.'s (TWSE:6906) Stock Is Going Strong: Have Financials A Role To Play?

Groundhog's (TWSE:6906) stock is up by a considerable 23% over the past 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 Groundhog's ROE in this article.

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

Check out our latest analysis for Groundhog

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 Groundhog is:

14% = NT$120m ÷ NT$860m (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.14 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. 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.

Groundhog's Earnings Growth And 14% ROE

To begin with, Groundhog seems to have a respectable ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. Despite the moderate return on equity, Groundhog has posted a net income growth of 5.0% over the past five years. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Groundhog's reported growth was lower than the industry growth of 13% over the last few years, which is not something we like to see.

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 Groundhog is trading on a high P/E or a low P/E, relative to its industry.

Is Groundhog Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 83% (that is, the company retains only 17% of its income) over the past three years for Groundhog suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Additionally, Groundhog started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Summary

On the whole, we do feel that Groundhog 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 3 risks we have identified for Groundhog.

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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.