With its stock down 3.8% over the past three months, it is easy to disregard Orient Telecoms (LON:ORNT). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Orient Telecoms' ROE.
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 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 return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Orient Telecoms is:
25% = UK£121k ÷ UK£482k (Based on the trailing twelve months to September 2021).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.25 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. 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.
Orient Telecoms' Earnings Growth And 25% ROE
To begin with, Orient Telecoms has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. As a result, Orient Telecoms' exceptional 65% net income growth seen over the past five years, doesn't come as a surprise.
We then compared Orient Telecoms' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 27% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ORNT fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Orient Telecoms Efficiently Re-investing Its Profits?
Orient Telecoms doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.
Overall, we are quite pleased with Orient Telecoms' performance. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 2 risks we have identified for Orient Telecoms visit our risks dashboard for free.
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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.