ACO Group Berhad (KLSE:ACO) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

ACO Group Berhad (KLSE:ACO) has had a great run on the share market with its stock up by a significant 10.0% over the last week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on ACO Group Berhad's ROE.

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.

See our latest analysis for ACO Group Berhad

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 ACO Group Berhad is:

6.4% = RM5.7m ÷ RM89m (Based on the trailing twelve months to February 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every MYR1 worth of equity, the company was able to earn MYR0.06 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

ACO Group Berhad's Earnings Growth And 6.4% ROE

At first glance, ACO Group Berhad's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.4%, so we won't completely dismiss the company. On the other hand, ACO Group Berhad reported a fairly low 2.8% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

As a next step, we compared ACO Group Berhad's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 24% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 ACO Group Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is ACO Group Berhad Making Efficient Use Of Its Profits?

A low three-year median payout ratio of 11% (implying that the company retains the remaining 89% of its income) suggests that ACO Group Berhad is retaining most of its profits. This should be reflected in its earnings growth number, but that's not the case. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, ACO Group Berhad has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we have mixed feelings about ACO Group Berhad. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 1 risk we have identified for ACO Group Berhad visit our risks dashboard for free.

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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.