Are Strong Financial Prospects The Force That Is Driving The Momentum In Redcentric plc's LON:RCN) Stock?

Redcentric (LON:RCN) has had a great run on the share market with its stock up by a significant 14% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Redcentric's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Redcentric

How Is ROE Calculated?

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 Redcentric is:

11% = UK£7.6m ÷ UK£72m (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Redcentric's Earnings Growth And 11% ROE

To begin with, Redcentric seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 8.8%. This certainly adds some context to Redcentric's exceptional 43% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Redcentric's growth is quite high when compared to the industry average growth of 26% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Redcentric fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Redcentric Efficiently Re-investing Its Profits?

Redcentric has a significant three-year median payout ratio of 59%, meaning the company only retains 41% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Additionally, Redcentric has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

In total, we are pretty happy with Redcentric's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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