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Most readers would already be aware that Verde Agritech's (TSE:NPK) stock increased significantly by 69% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Verde Agritech's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Verde Agritech is:
13% = CA$3.5m ÷ CA$26m (Based on the trailing twelve months to December 2021).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.13 in profit.
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. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Verde Agritech's Earnings Growth And 13% ROE
At first glance, Verde Agritech seems to have a decent ROE. Even when compared to the industry average of 16% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 49% seen over the past five years by Verde Agritech. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Verde Agritech's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 23%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Verde Agritech fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Verde Agritech Using Its Retained Earnings Effectively?
Given that Verde Agritech doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
On the whole, we feel that Verde Agritech's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for Verde Agritech by visiting our risks dashboard for free on our platform here.
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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.