Is the recent stock performance of Ergomed plc (LON: ERGO) linked to its strong fundamentals?

Most readers already know that the stock of Ergomed (LON: ERGO) has increased significantly by 20% in the last three months. Given the company’s impressive performance, we decided to take a closer look at its financial metrics, as a company’s long-term financial health usually dictates market results. Specifically, we decided to study Ergomed’s ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

See our latest review for Ergomed

How to calculate return on equity?

ROE can be calculated using the formula:

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

So, based on the above formula, the ROE for Ergomed is:

18% = £ 9.7million £ 53million (based on the last twelve months to December 2020).

The “return” is the amount earned after tax over the past twelve months. Another way to think about this is that for every £ 1 worth of equity, the company was able to make £ 0.18 in profit.

Why is ROE important for profit growth?

We have already established that ROE is an effective indicator of profit generation for a company’s future profits. Based on the portion of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming everything else is equal, companies that have both a higher return on equity and higher profit retention are generally those that have a higher growth rate than companies that do not have the same characteristics.

A side-by-side comparison of Ergomed’s profit growth and 18% ROE

At first glance, Ergomed appears to have a decent ROE. Even compared to the industry average of 16%, the company’s ROE looks pretty decent. This certainly adds context to Ergomed’s exceptional net profit growth of 27% observed over the past five years. However, other drivers could also be behind this growth. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout rate.

We then performed a comparison between Ergomed’s net income growth with industry, which found that the company’s growth is similar to the industry’s average growth of 27% over the same period.

OBJECTIVE: ERGO Growth in past profits on September 24, 2021

Profit growth is a huge factor in the valuation of stocks. What investors next need to determine is whether the expected earnings growth, or lack thereof, is already built into the share price. This then helps them determine whether the stock is set for a bright or dark future. Has the market assessed ERGO’s future prospects? You can find out in our latest Intrinsic Value infographic research report.

Does Ergomed effectively reinvest its profits?

Ergomed does not currently pay any dividends, which essentially means that it has reinvested all of its profits back into the business. This certainly contributes to the high number of profit growth we discussed above.

Summary

Overall, we are quite satisfied with Ergomed’s performance. In particular, we like the fact that the company is reinvesting heavily in its business and at a high rate of return. Unsurprisingly, this led to impressive profit growth. That said, the latest forecasts from industry analysts show that the company’s earnings growth is expected to slow. To learn more about the latest analyst forecast for the business, check out this visualization of the analyst forecast for the business.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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