SHAPE Australia (ASX:SHA) has had a rough three months with its share price down 1.9%. 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. In this article, we decided to focus on SHAPE Australia's ROE.
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.
Check out our latest analysis for SHAPE Australia
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for SHAPE Australia is:
25% = AU$6.1m ÷ AU$24m (Based on the trailing twelve months to December 2022).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.25.
What Has ROE Got To Do With 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. 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.
SHAPE Australia's Earnings Growth And 25% ROE
First thing first, we like that SHAPE Australia has an impressive ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. Needless to say, we are quite surprised to see that SHAPE Australia's net income shrunk at a rate of 8.9% over the past five years. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared SHAPE Australia's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 21% in the same period.
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. 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 SHAPE Australia is trading on a high P/E or a low P/E, relative to its industry.