Most readers would already be aware that EG Industries Berhad's (KLSE:EG) stock increased significantly by 69% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on EG Industries Berhad's ROE.
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 EG Industries Berhad
How Is ROE Calculated?
Return on equity 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 EG Industries Berhad is:
4.6% = RM18m ÷ RM387m (Based on the trailing twelve months to September 2022).
The 'return' is the income the business earned over the last year. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.05 in profit.
Why Is ROE Important For 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.
EG Industries Berhad's Earnings Growth And 4.6% ROE
It is quite clear that EG Industries Berhad's ROE is rather low. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. For this reason, EG Industries Berhad's five year net income decline of 16% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
However, when we compared EG Industries Berhad's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.7% in the same period. This is quite worrisome.
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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if EG Industries Berhad is trading on a high P/E or a low P/E, relative to its industry.