Most readers would already be aware that Gamma Communications' (LON:GAMA) stock increased significantly by 13% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Gamma Communications' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Gamma Communications

How Do You 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 Gamma Communications is:

16% = UK￡54m ÷ UK￡344m (Based on the trailing twelve months to December 2023).

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 ￡0.16 in profit.

What Has ROE Got To Do With Earnings Growth?

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

Gamma Communications' Earnings Growth And 16% ROE

To begin with, Gamma Communications seems to have a respectable ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 10% seen over the past five years by Gamma Communications.

We then compared Gamma Communications' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same 5-year period, which is a bit concerning.

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). Doing so will help them establish if the stock's future looks promising or ominous. Is GAMA fairly valued? This infographic on the company's intrinsic value has everything you need to know.