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Redcentric (LON: RCN) had a tough month with its share price down 10%. However, stock prices are usually determined by a company’s financial metrics over the long term, which look pretty handsome in this case. We pay particular attention to this Redcentrics ROE today.
Return on Equity, or ROE, is an important metric for assessing how efficiently a company’s management is using the company’s capital. In other words, it’s a profitability metric that measures the return on the capital provided by the company’s shareholders.
Check out our latest analysis for Redcentric
How do you calculate the return on equity?
The Formula for return on equity is:
Return on Equity = Net Income (from continuing operations) ÷ Equity
Based on the formula above, the ROE for Redcentric is:
12% = UK £ 9.2m ÷ UKGB 76m (based on the last twelve months through March 2021).
The “return” is the amount earned after tax over the past twelve months. One way to conceptualize this is that for every £ 1 of its stockholders’ equity the company made a profit of £ 0.12.
What does ROE have to do with earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. Based on how much of its profits the company will reinvest or “keep”, we can then evaluate a company’s future ability to generate profits. Assuming everything else stays the same, the higher the rate of growth of a company compared to companies that do not necessarily have these characteristics, the higher the ROE and retained earnings.
Redcentrics earnings growth and 12% ROE
At first glance, Redcentric seems to have a decent ROE. In addition, the company’s ROE is equivalent to the industry average of 11%. Even so, Redcentric’s five-year net income growth has been pretty flat over the past five years. Because of this, we believe that there might be other reasons not discussed so far in this article that might be hindering the company’s growth. For example, it may be that the company has a high payout ratio or the company has poorly allocated capital, for example.
As a next step, we compared Redcentric’s net income growth to that of the industry and found that the industry experienced an average growth of 18% over the same period.
The basis for increasing the value of a company is largely linked to its earnings development. Next, investors need to determine whether or not expected earnings growth is already included in the stock price. That way, they can determine whether the future of the stock looks promising or ominous. Is RCN rated fairly? These Infographic on the intrinsic value of the company has everything you need to know.
Is Redcentric reinvesting its profits efficiently?
Redcentric has a high LTM payout ratio (or last twelve months) of 60% (or a 40% retention rate), which means the company pays most of its profits to its shareholders as dividends. This, in a way, explains why the revenues haven’t grown.
Additionally, Redcentric has paid dividends over a seven-year period, which means the company’s management is determined to pay dividends, even if it means little or no earnings growth. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 44% over the next three years. The fact that the company’s ROE should increase to 16% in the same period is explained by the lower payout ratio.
Summary
Overall, we think Redcentric certainly has some positive factors to consider. However, we are disappointed that, despite a high ROE, earnings are not growing. Keep in mind that the company will reinvest a small portion of its profits, which means that investors will not benefit from the high returns. Additionally, after studying the latest analyst estimates, we have determined that the company’s earnings are expected to continue to shrink in the future. To learn more about the company’s future earnings growth projections, take a look at this free Report on analyst forecast for the company to learn more.
This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which is sensitive to the price. Simply Wall St has no position in the stocks mentioned.
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