It is hard to get excited after looking at InNature Berhad's (KLSE:INNATURE) recent performance, when its stock has declined 16% over the past three months. 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. Specifically, we decided to study InNature Berhad'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for InNature Berhad

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 InNature Berhad is:

14% = RM20m ÷ RM138m (Based on the trailing twelve months to March 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.14 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

InNature Berhad's Earnings Growth And 14% ROE

To start with, InNature Berhad's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 16%. However, while InNature Berhad has a pretty respectable ROE, its five year net income decline rate was 22% . So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

That being said, we compared InNature Berhad's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.0% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is INNATURE fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is InNature Berhad Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 76% (implying that 24% of the profits are retained), most of InNature Berhad's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 2 risks we have identified for InNature Berhad visit our risks dashboard for free.

In addition, InNature Berhad only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 83%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 17%.

Conclusion

In total, it does look like InNature Berhad has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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