Are Robust Financials Driving The Recent Rally In Pentamaster International Limited's (HKG:1665) Stock?

Pentamaster International (HKG:1665) has had a great run on the share market with its stock up by a significant 10% over the last week. 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 Pentamaster International's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Pentamaster International

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 Pentamaster International is:

18% = RM145m ÷ RM818m (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.18 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Pentamaster International's Earnings Growth And 18% ROE

To begin with, Pentamaster International seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Probably as a result of this, Pentamaster International was able to see a decent growth of 5.4% over the last five years.

Next, on comparing with the industry net income growth, we found that Pentamaster International's reported growth was lower than the industry growth of 23% over the last few years, which is not something we like to see.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Pentamaster International is trading on a high P/E or a low P/E, relative to its industry.

Is Pentamaster International Efficiently Re-investing Its Profits?

In Pentamaster International's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 19% (or a retention ratio of 81%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Pentamaster International is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. 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 20%. Accordingly, forecasts suggest that Pentamaster International's future ROE will be 19% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Pentamaster International's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.