African Media Entertainment Limited (JSE:AME) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

African Media Entertainment's (JSE:AME) stock is up by a considerable 13% over the past week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study African Media Entertainment's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for African Media Entertainment

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 African Media Entertainment is:

15% = R38m ÷ R256m (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.15 in profit.

What Has ROE Got To Do With 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. 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.

African Media Entertainment's Earnings Growth And 15% ROE

On the face of it, African Media Entertainment's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 7.7% doesn't go unnoticed by us. But then again, seeing that African Media Entertainment's net income shrunk at a rate of 24% in the past five years, makes us think again. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the decline in earnings could also be the result of this.

However, when we compared African Media Entertainment's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.2% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 African Media Entertainment is trading on a high P/E or a low P/E, relative to its industry.

Is African Media Entertainment Making Efficient Use Of Its Profits?

African Media Entertainment's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 75% (or a retention ratio of 25%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 4 risks we have identified for African Media Entertainment by visiting our risks dashboard for free on our platform here.

Additionally, African Media Entertainment has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we're a bit ambivalent about African Media Entertainment's performance. On the one hand, the company does have a decent rate of return, however, its earnings growth number is quite disappointing and as discussed earlier, the low retained earnings is hampering the growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on African Media Entertainment and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.