Is Volcano Berhad's (KLSE:VOLCANO) Recent Price Movement Underpinned By Its Weak Fundamentals?

Volcano Berhad (KLSE:VOLCANO) has had a rough three months with its share price down 21%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Volcano Berhad's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Volcano 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 Volcano Berhad is:

5.5% = RM5.7m ÷ RM104m (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.06 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. 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 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 Volcano Berhad's Earnings Growth And 5.5% ROE

It is hard to argue that Volcano Berhad's ROE is much good in and of itself. Even compared to the average industry ROE of 8.4%, the company's ROE is quite dismal. Hence, the flat earnings seen by Volcano Berhad over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared Volcano 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 7.5% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for VOLCANO? You can find out in our latest intrinsic value infographic research report

Is Volcano Berhad Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 30% (implying that the company keeps 70% of its income) over the last three years, Volcano Berhad has seen a negligible amount of growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Only recently, Volcano Berhad started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Summary

Overall, we have mixed feelings about Volcano 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. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Volcano Berhad's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.