Verbrec (ASX:VBC) has had a great run on the stock market, with its stock up a remarkable 19% over the past month. As most people know, it is usually the fundamentals that determine market price movements in the long term, so today we decided to look at the company’s key financial indicators to see if they play a role in the recent price movement. In particular, we decided to examine Verbrec’s return on equity in this article.

Return on equity (ROE) is a measure of how effectively a company increases its value and manages its investors’ money. In simpler terms, it measures a company’s profitability relative to shareholders’ equity.

Check out our latest analysis for Verbrec

How do you calculate return on equity?

Return on equity can be calculated using the following formula:

Return on equity = Net profit (from continuing operations) ÷ Equity

Based on the above formula, the ROE for Verbrec is:

25% = AU$4.8 million ÷ AU$19 million (based on the trailing twelve months to June 2024).

The “return” is the income that the company generated in the last year. You can also imagine it like this: for every 1 Australian dollar of equity, the company was able to generate 0.25 Australian dollars in profit.

What does return on equity (ROE) have to do with earnings growth?

So far, we’ve learned that return on equity is a measure of a company’s profitability. Depending on how much of those profits the company reinvests or “retains” and how effectively it does so, we can judge a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the return on equity and earnings retention, the higher a company’s growth rate will be compared to companies that don’t necessarily have those characteristics.

A comparison of Verbrec’s earnings growth and 25% ROE

First of all, Verbrec has a pretty high return on equity, which is interesting. In addition, the company’s return on equity is higher than the industry average of 13%, which is quite remarkable. It goes without saying that we are quite surprised to see that Verbrec’s net income has shrunk by 26% over the past five years. So there could be other aspects that could explain this. For example, the company pays out a large portion of its profits as dividends or faces competitive pressures.

Next, we compared Verbrec’s performance with the industry. We were disappointed to see that while the company has suffered a decline in profits, the industry has grown by 21% over the past few years.

Earnings growth is an important factor in stock valuation. The investor should try to determine if the expected earnings growth or expected earnings decline, whichever may be the case, is reflected in the price. This will then help them determine if the stock is positioned for a good or bad future. Is Verbrec fairly valued compared to other companies? These 3 valuation metrics could help you decide.

The story continues

Does Verbrec reinvest its profits efficiently?

Since Verbrec doesn’t pay regular dividends, we assume that the company retains all its profits. This is quite puzzling considering that it has no earnings growth to show. It looks like there could be other reasons explaining the lack in this regard. For example, the business could be declining.

Summary

Overall, it seems like there are some positives to Verbrec’s business. Still, the low earnings growth is a little concerning, especially considering that the company generates a high return and reinvests a large portion of its profits. As it stands, there could be other factors that are not necessarily in the company’s control that are preventing growth. While we are not dismissing the company outright, we would try to determine the company’s riskiness to make a more informed decision about the company. Our risk dashboard would include the two risks we have identified for Verbrec.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.