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Do Its Financials Have Any Role To Play In Driving ADvTECH Limited's (JSE:ADH) Stock Up Recently?
Most readers would already be aware that ADvTECH's (JSE:ADH) stock increased significantly by 15% over the past 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. Specifically, we decided to study ADvTECH's ROE in this article.
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 ADvTECH
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for ADvTECH is:
11% = R411m ÷ R3.7b (Based on the trailing twelve months to June 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.11 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. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
ADvTECH's Earnings Growth And 11% ROE
It is hard to argue that ADvTECH's ROE is much good in and of itself. Even when compared to the industry average of 20%, the ROE figure is pretty disappointing. However, the moderate 13% net income growth seen by ADvTECH over the past five years is definitely a positive. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared ADvTECH's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 ADvTECH is trading on a high P/E or a low P/E, relative to its industry.
Is ADvTECH Efficiently Re-investing Its Profits?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.
Summary
On the whole, we do feel that ADvTECH has some positive attributes. 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. You can see the 2 risks we have identified for ADvTECH 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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About JSE:ADH
ADvTECH
Provides education, training, and staff placement services in South Africa, other African countries, and internationally.
Proven track record with adequate balance sheet.