With its stock down 4.0% over the past month, it is easy to disregard Good Drinks Australia (ASX:GDA). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Good Drinks Australia's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for Good Drinks Australia
How To 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 Good Drinks Australia is:
3.1% = AU$2.0m ÷ AU$64m (Based on the trailing twelve months to June 2022).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.03 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.
Good Drinks Australia's Earnings Growth And 3.1% ROE
As you can see, Good Drinks Australia's ROE looks pretty weak. Even when compared to the industry average of 5.0%, the ROE figure is pretty disappointing. Good Drinks Australia was still able to see a decent net income growth of 9.5% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing Good Drinks Australia's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 9.5% in the same period.
Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Good Drinks Australia is trading on a high P/E or a low P/E, relative to its industry.
Is Good Drinks Australia Using Its Retained Earnings Effectively?
Good Drinks Australia doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the decent earnings growth number that we discussed above.
In total, it does look like Good Drinks Australia has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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. You can see the 2 risks we have identified for Good Drinks Australia by visiting our risks dashboard for free on our platform here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Join A Paid User Research Session
You'll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here