Could The Market Be Wrong About Lii Hen Industries Bhd (KLSE:LIIHEN) Given Its Attractive Financial Prospects?

Lii Hen Industries Bhd (KLSE:LIIHEN) has had a rough month with its share price down 10%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Lii Hen Industries Bhd's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Lii Hen Industries Bhd

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Lii Hen Industries Bhd is:

19% = RM79m ÷ RM421m (Based on the trailing twelve months to December 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.19 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Lii Hen Industries Bhd's Earnings Growth And 19% ROE

To start with, Lii Hen Industries Bhd's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. Despite this, Lii Hen Industries Bhd's five year net income growth was quite low averaging at only 2.4%. That's a bit unexpected from a company which has such a high rate of return. 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.

Given that the industry shrunk its earnings at a rate of 0.8% in the same period, the net income growth of the company is quite impressive.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Lii Hen Industries Bhd is trading on a high P/E or a low P/E, relative to its industry.

Is Lii Hen Industries Bhd Making Efficient Use Of Its Profits?

While Lii Hen Industries Bhd has a decent three-year median payout ratio of 38% (or a retention ratio of 62%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Lii Hen Industries Bhd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 42%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 17%.

Summary

Overall, we are quite pleased with Lii Hen Industries Bhd's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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