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With its stock down 29% over the past three months, it is easy to disregard Advance NanoTek (ASX:ANO). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Advance NanoTek's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Advance NanoTek
How Do You Calculate Return On Equity?
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 Advance NanoTek is:
19% = AU$5.3m ÷ AU$28m (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.19 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Advance NanoTek's Earnings Growth And 19% ROE
To start with, Advance NanoTek's ROE looks acceptable. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. This certainly adds some context to Advance NanoTek's exceptional 66% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.
We then compared Advance NanoTek's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 43% 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). 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 Advance NanoTek is trading on a high P/E or a low P/E, relative to its industry.