Turbo-Mech Berhad (KLSE:TURBO) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Most readers would already be aware that Turbo-Mech Berhad's (KLSE:TURBO) stock increased significantly by 36% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Turbo-Mech Berhad's ROE today.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Turbo-Mech Berhad

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 Turbo-Mech Berhad is:

5.4% = RM6.0m ÷ RM111m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax 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 MYR0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Turbo-Mech Berhad's Earnings Growth And 5.4% ROE

It is quite clear that Turbo-Mech Berhad's ROE is rather low. Further, we noted that the company's ROE is similar to the industry average of 5.4%. Therefore, it might not be wrong to say that the five year net income decline of 4.9% seen by Turbo-Mech Berhad was possibly a result of the disappointing ROE.

As a next step, we compared Turbo-Mech Berhad's performance with the industry and found thatTurbo-Mech Berhad's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 3.0% in the same period, which is a slower than the company.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Turbo-Mech Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is Turbo-Mech Berhad Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 34% (or a retention ratio of 66%) which is pretty normal, Turbo-Mech Berhad's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Turbo-Mech Berhad has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we have mixed feelings about Turbo-Mech Berhad. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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. Our risks dashboard would have the 3 risks we have identified for Turbo-Mech Berhad.

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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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