It is hard to get excited after looking at Ocean Bio-Chem's (NASDAQ:OBCI) recent performance, when its stock has declined 9.1% over the past week. 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 Ocean Bio-Chem's ROE today.
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 Ocean Bio-Chem is:
26% = US$11m ÷ US$42m (Based on the trailing twelve months to March 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.26 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.
Ocean Bio-Chem's Earnings Growth And 26% ROE
To begin with, Ocean Bio-Chem has a pretty high ROE which is interesting. Further, even comparing with the industry average if 23%, the company's ROE is quite respectable. Therefore, it might not be wrong to say that the impressive five year 39% net income growth seen by Ocean Bio-Chem was probably achieved as a result of the high ROE.
Next, on comparing with the industry net income growth, we found that Ocean Bio-Chem's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Ocean Bio-Chem is trading on a high P/E or a low P/E, relative to its industry.
Is Ocean Bio-Chem Efficiently Re-investing Its Profits?
Ocean Bio-Chem's three-year median payout ratio to shareholders is 5.0%, which is quite low. This implies that the company is retaining 95% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, Ocean Bio-Chem is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend.
Overall, we are quite pleased with Ocean Bio-Chem's performance. 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 substantial growth in its earnings.
When trading Ocean Bio-Chem or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.