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Gear4music (Holdings) plc's (LON:G4M) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

editorial-team@simplywallst.com (Simply Wall St)
·3-min read

Most readers would already be aware that Gear4music (Holdings)'s (LON:G4M) stock increased significantly by 31% over the past week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Gear4music (Holdings)'s ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Gear4music (Holdings)

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

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So, based on the above formula, the ROE for Gear4music (Holdings) is:

1.7% = UK£651k ÷ UK£38m (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.02 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Gear4music (Holdings)'s Earnings Growth And 1.7% ROE

As you can see, Gear4music (Holdings)'s ROE looks pretty weak. Even when compared to the industry average of 12%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 37% seen by Gear4music (Holdings) was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Gear4music (Holdings)'s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 13% in the same 5-year period.

past-earnings-growth
past-earnings-growth

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. Has the market priced in the future outlook for G4M? You can find out in our latest intrinsic value infographic research report.

Is Gear4music (Holdings) Efficiently Re-investing Its Profits?

Gear4music (Holdings) doesn't pay any regular dividends, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Summary

Overall, we have mixed feelings about Gear4music (Holdings). While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 2 risks we have identified for Gear4music (Holdings).

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com