AudioCodes (NASDAQ:AUDC) has had a great run on the share market with its stock up by a significant 43% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on AudioCodes' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for AudioCodes is:

7.1% = US$13m ÷ US$179m (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.07.

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. 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.

AudioCodes' Earnings Growth And 7.1% ROE

When you first look at it, AudioCodes' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 9.5%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 15% net income growth seen by AudioCodes over the past five years is definitely a positive. So, the growth in the company's earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared AudioCodes' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 29% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is AUDC worth today? The intrinsic value infographic in our free research report helps visualize whether AUDC is currently mispriced by the market.

Is AudioCodes Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 38% (implying that the company retains 62% of its profits), it seems that AudioCodes is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

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

Summary

In total, it does look like AudioCodes has some positive aspects to its business. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.