With its stock down 3.6% over the past week, it is easy to disregard Image Sensing Systems (NASDAQ:ISNS). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Image Sensing Systems' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Image Sensing Systems is:
5.5% = US$1.1m ÷ US$19m (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.05 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Image Sensing Systems' Earnings Growth And 5.5% ROE
On the face of it, Image Sensing Systems' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 11% either. However, we we're pleasantly surprised to see that Image Sensing Systems grew its net income at a significant rate of 38% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Image Sensing Systems' growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Image Sensing Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Image Sensing Systems Using Its Retained Earnings Effectively?
Overall, we feel that Image Sensing Systems certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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 Image Sensing Systems.
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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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