Yahoo Finance Declining Stock and Decent Financials: Is The Market Wrong About African Media Entertainment Limited (JSE:AME)?
It is hard to get excited after looking at African Media Entertainment's (JSE:AME) recent performance, when its stock has declined 9.9% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study African Media Entertainment's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for African Media Entertainment
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for African Media Entertainment is:
19% = R47m ÷ R255m (Based on the trailing twelve months to September 2023).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every ZAR1 worth of equity, the company was able to earn ZAR0.19 in profit.
Why Is ROE Important For 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 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.
African Media Entertainment's Earnings Growth And 19% ROE
To begin with, African Media Entertainment seems to have a respectable ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Needless to say, we are quite surprised to see that African Media Entertainment's net income shrunk at a rate of 15% over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
So, as a next step, we compared African Media Entertainment's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 17% over the last few years.
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. This then helps them determine if the stock is placed for a bright or bleak future. 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 African Media Entertainment is trading on a high P/E or a low P/E, relative to its industry.
Is African Media Entertainment Efficiently Re-investing Its Profits?
African Media Entertainment has a high three-year median payout ratio of 73% (that is, it is retaining 27% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 3 risks we have identified for African Media Entertainment visit our risks dashboard for free.
Moreover, African Media Entertainment has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
Summary
In total, it does look like African Media Entertainment has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into African Media Entertainment's past profit growth, check out this visualization of past earnings, revenue and cash flows.
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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.
