Pure Cycle's (NASDAQ:PCYO) stock is up by a considerable 22% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Pure Cycle's ROE today.
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.
How To 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 Pure Cycle is:
8.5% = US$9.6m ÷ US$113m (Based on the trailing twelve months to August 2022).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.09.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
A Side By Side comparison of Pure Cycle's Earnings Growth And 8.5% ROE
On the face of it, Pure Cycle's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 8.7%, we may spare it some thought. Moreover, we are quite pleased to see that Pure Cycle's net income grew significantly at a rate of 47% over the last five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Pure Cycle's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.5%.
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. Is Pure Cycle fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Pure Cycle Using Its Retained Earnings Effectively?
Given that Pure Cycle doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
Overall, we feel that Pure Cycle certainly does have some positive factors to consider. 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. To know the 1 risk we have identified for Pure Cycle visit our risks dashboard for free.
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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.
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