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McChip Resources (CVE:MCS) has had a great run on the share market with its stock up by a significant 35% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study McChip Resources' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 McChip Resources is:
42% = CA$2.5m ÷ CA$6.1m (Based on the trailing twelve months to March 2021).
The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.42 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. 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 McChip Resources' Earnings Growth And 42% ROE
To begin with, McChip Resources has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. Probably as a result of this, McChip Resources was able to see a decent net income growth of 11% over the last five years.
As a next step, we compared McChip Resources' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 20% in the same period.
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 McChip Resources fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is McChip Resources Using Its Retained Earnings Effectively?
McChip Resources' three-year median payout ratio to shareholders is 8.3% (implying that it retains 92% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Moreover, McChip Resources is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.
In total, we are pretty happy with McChip Resources' 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. To know the 5 risks we have identified for McChip Resources visit our risks dashboard for free.
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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