OTS Holdings (Catalist:OTS) has had a rough three months with its share price down 17%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on OTS Holdings' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for OTS Holdings
How Do You Calculate Return On Equity?
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 OTS Holdings is:
0.6% = S$176k ÷ S$29m (Based on the trailing twelve months to December 2022).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.01 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
OTS Holdings' Earnings Growth And 0.6% ROE
It is quite clear that OTS Holdings' ROE is rather low. Even when compared to the industry average of 9.3%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 19% seen by OTS Holdings was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
However, when we compared OTS Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 22% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. 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. 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 OTS Holdings is trading on a high P/E or a low P/E, relative to its industry.