Could The Market Be Wrong About Educational Development Corporation (NASDAQ:EDUC) Given Its Attractive Financial Prospects?

Educational Development (NASDAQ:EDUC) has had a rough month with its share price down 14%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Educational Development's ROE.

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.

Check out our latest analysis for Educational Development

How Is ROE Calculated?

ROE 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 Educational Development is:

27% = US$9.5m ÷ US$35m (Based on the trailing twelve months to August 2020).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.27 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.

Educational Development's Earnings Growth And 27% ROE

To begin with, Educational Development has a pretty high ROE which is interesting. Further, even comparing with the industry average if 31%, the company's ROE is quite respectable. As a result, Educational Development's remarkable 26% net income growth seen over the past 5 years is likely aided by its high ROE.

As a next step, we compared Educational Development'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 15%.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Educational Development's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Educational Development Efficiently Re-investing Its Profits?

Educational Development's three-year median payout ratio to shareholders is 22%, which is quite low. This implies that the company is retaining 78% of its profits. So it looks like Educational Development is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Educational Development has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

On the whole, we feel that Educational Development'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 substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 1 risk we have identified for Educational Development by visiting our risks dashboard for free on our platform here.

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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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