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Is African Media Entertainment Limited's (JSE:AME) Recent Price Movement Underpinned By Its Weak Fundamentals?

With its stock down 7.8% over the past month, it is easy to disregard African Media Entertainment (JSE:AME). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to African Media Entertainment's ROE today.

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. 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?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for African Media Entertainment is:

15% = R38m ÷ R256m (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ZAR1 worth of equity, the company was able to earn ZAR0.15 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. 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.

African Media Entertainment's Earnings Growth And 15% ROE

On the face of it, African Media Entertainment's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 7.0% doesn't go unnoticed by us. However, African Media Entertainment's five year net income decline rate was 24%. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to shrink.

That being said, we compared African Media Entertainment'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 8.2% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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?

With a high three-year median payout ratio of 75% (implying that 25% of the profits are retained), most of African Media Entertainment's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 4 risks we have identified for African Media Entertainment by visiting our risks dashboard for free on our platform here.

In addition, African Media Entertainment has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

In total, we're a bit ambivalent about African Media Entertainment's performance. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. 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.

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.

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