Looking at Innovotech’s (CVE:IOT) mostly flat share price movement over the past week, it is easy to think that there’s nothing interesting about the stock. However, its worth giving the company a closer given that its key financial performance indicators aren’t particularly bad and long-term financial health is usually what drive market prices. Particularly, we will be paying attention to Innovotech’s ROE today.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 Innovotech is:
9.6% = CA$55k ÷ CA$576k (Based on the trailing twelve months to September 2020).
The ‘return’ is the yearly profit. One way to conceptualize this is that for each CA$1 of shareholders’ capital it has, the company made CA$0.10 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 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.
Innovotech’s Earnings Growth And 9.6% ROE
To start with, Innovotech’s ROE looks acceptable. Even so, when compared with the average industry ROE of 14%, we aren’t very excited. However, the moderate 13% net income growth seen by Innovotech over the past five years is definitely a positive. So, there might be other aspects that are positively influencing earnings growth. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also provides some context to the earnings growth seen by the company.
Next, on comparing with the industry net income growth, we found that Innovotech’s reported growth was lower than the industry growth of 17% in the same period, which is not something we like to see.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you’re wondering about Innovotech’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Innovotech Making Efficient Use Of Its Profits?
On the whole, we do feel that Innovotech has some positive attributes. Particularly, its earnings have grown respectably as we saw earlier, which was likely achieved due to the company reinvesting most of its earnings at a decent rate of return, to grow 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 4 risks we have identified for Innovotech.
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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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