Is Macmahon Holdings Limited's(ASX:MAH) Recent Stock Performance Tethered To Its Strong Fundamentals?

Most readers would already be aware that Macmahon Holdings' (ASX:MAH) stock increased significantly by 17% 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. In this article, we decided to focus on Macmahon Holdings' 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.

View our latest analysis for Macmahon Holdings

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Macmahon Holdings is:

13% = AU$65m ÷ AU$498m (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.13 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. 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.

A Side By Side comparison of Macmahon Holdings' Earnings Growth And 13% ROE

At first glance, Macmahon Holdings seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 13%. Consequently, this likely laid the ground for the impressive net income growth of 78% seen over the past five years by Macmahon Holdings. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Macmahon Holdings' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 32% in the same period.

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 Macmahon Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Macmahon Holdings Making Efficient Use Of Its Profits?

Macmahon Holdings has a three-year median payout ratio of 27% (where it is retaining 73% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Macmahon Holdings is reinvesting its earnings efficiently.

Moreover, Macmahon Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 19% over the next three years. However, Macmahon Holdings' future ROE is expected to decline to 9.9% despite the expected decline in its payout ratio. We infer that there could be other factors that could be steering the foreseen decline in the company's ROE.

Conclusion

In total, we are pretty happy with Macmahon Holdings' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. 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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