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Grand Gulf Energy (ASX:GGE) has had a great run on the share market with its stock up by a significant 280% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Grand Gulf Energy'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 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 Grand Gulf Energy is:
4.3% = AU$115k ÷ AU$2.7m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.04 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Grand Gulf Energy's Earnings Growth And 4.3% ROE
On the face of it, Grand Gulf Energy's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 4.9%. Particularly, the exceptional 64% net income growth seen by Grand Gulf Energy over the past five years is pretty remarkable. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Grand Gulf Energy's growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Grand Gulf Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Grand Gulf Energy Using Its Retained Earnings Effectively?
Given that Grand Gulf Energy doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
Overall, we feel that Grand Gulf Energy certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 6 risks we have identified for Grand Gulf Energy.
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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