Should Weakness in Gold Road Resources Limited's (ASX:GOR) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

·4 min read

With its stock down 8.3% over the past week, it is easy to disregard Gold Road Resources (ASX:GOR). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Gold Road Resources' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Gold Road Resources

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 Gold Road Resources is:

18% = AU$77m ÷ AU$427m (Based on the trailing twelve months to June 2021).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.18.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Gold Road Resources' Earnings Growth And 18% ROE

To start with, Gold Road Resources' ROE looks acceptable. On comparing with the average industry ROE of 13% the company's ROE looks pretty remarkable. For this reason, Gold Road Resources' five year net income decline of 27% raises the question as to why the high ROE didn't translate into earnings growth. 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. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

However, when we compared Gold Road Resources' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 25% in the same period. This is quite worrisome.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Gold Road Resources''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Gold Road Resources Efficiently Re-investing Its Profits?

Gold Road Resources' low three-year median payout ratio of 20% (or a retention ratio of 80%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Additionally, Gold Road Resources started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 26% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

On the whole, we do feel that Gold Road Resources has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.

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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