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With its stock down 7.2% over the past three months, it is easy to disregard EMCORE (NASDAQ:EMKR). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study EMCORE'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.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for EMCORE is:
16% = US$21m ÷ US$131m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.16.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of EMCORE's Earnings Growth And 16% ROE
At first glance, EMCORE seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 15%. However, while EMCORE has a pretty respectable ROE, its five year net income decline rate was 23% . So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
However, when we compared EMCORE's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 0.8% in the same period. This is quite worrisome.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about EMCORE's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is EMCORE Making Efficient Use Of Its Profits?
EMCORE doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In total, it does look like EMCORE has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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.
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