Is Weakness In Max Stock Ltd. (TLV:MAXO) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 20% over the past three months, it is easy to disregard Max Stock (TLV:MAXO). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Max Stock's ROE in this article.

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.

Check out our latest analysis for Max Stock

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Max Stock is:

48% = ₪89m ÷ ₪185m (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₪1 worth of equity, the company was able to earn ₪0.48 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Max Stock's Earnings Growth And 48% ROE

To begin with, Max Stock has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 6.5% the company's ROE is quite impressive. Despite this, Max Stock's five year net income growth was quite low averaging at only 4.0%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Max Stock's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 0.7%.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for MAXO? You can find out in our latest intrinsic value infographic research report

Is Max Stock Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 86% (that is, the company retains only 14% of its income) over the past three years for Max Stock suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Additionally, Max Stock started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth.

Conclusion

Overall, we are quite pleased with Max Stock's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for Max Stock by visiting our risks dashboard for free on our platform here.

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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.