Is Ava Risk Group Limited's (ASX:AVA) Latest Stock Performance A Reflection Of Its Financial Health?

Most readers would already be aware that Ava Risk Group's (ASX:AVA) stock increased significantly by 76% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Ava Risk Group's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Ava Risk Group

How Do You Calculate Return On Equity?

ROE 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 Ava Risk Group is:

19% = AU$4.9m ÷ AU$25m (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.

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.

A Side By Side comparison of Ava Risk Group's Earnings Growth And 19% ROE

At first glance, Ava Risk Group seems to have a decent ROE. On comparing with the average industry ROE of 13% the company's ROE looks pretty remarkable. This certainly adds some context to Ava Risk Group's decent 5.3% net income growth seen over the past five years.

As a next step, we compared Ava Risk Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% in the same period.

past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Ava Risk Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Ava Risk Group Efficiently Re-investing Its Profits?

Ava Risk Group doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the decent earnings growth number that we discussed above.

Conclusion

In total, we are pretty happy with Ava Risk Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Ava Risk Group by visiting our risks dashboard for free on our platform here.

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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