Should Weakness in Homeritz Corporation Berhad's (KLSE:HOMERIZ) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Homeritz Corporation Berhad (KLSE:HOMERIZ) has had a rough month with its share price down 25%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Homeritz Corporation Berhad's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Homeritz Corporation Berhad

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Homeritz Corporation Berhad is:

13% = RM24m ÷ RM176m (Based on the trailing twelve months to August 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.13 in profit.

Why Is ROE Important For Earnings Growth?

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

Homeritz Corporation Berhad's Earnings Growth And 13% ROE

To begin with, Homeritz Corporation Berhad seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Needless to say, we are quite surprised to see that Homeritz Corporation Berhad's net income shrunk at a rate of 5.4% over the past five years. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 3.8% in the same period, we found that Homeritz Corporation Berhad's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Homeritz Corporation Berhad's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Homeritz Corporation Berhad Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 38% (that is, a retention ratio of 62%), the fact that Homeritz Corporation Berhad's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Homeritz Corporation 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. 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 39%. Accordingly, forecasts suggest that Homeritz Corporation Berhad's future ROE will be 13% which is again, similar to the current ROE.

Summary

In total, it does look like Homeritz Corporation Berhad has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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