Wegmans Holdings Berhad (KLSE:WEGMANS) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Wegmans Holdings Berhad (KLSE:WEGMANS) has had a great run on the share market with its stock up by a significant 22% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Wegmans Holdings Berhad's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Wegmans Holdings Berhad

How To Calculate Return On Equity?

ROE 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 Wegmans Holdings Berhad is:

6.3% = RM5.0m ÷ RM80m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made 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. 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. 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.

Wegmans Holdings Berhad's Earnings Growth And 6.3% ROE

On the face of it, Wegmans Holdings Berhad's ROE is not much to talk about. Next, when compared to the average industry ROE of 9.1%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 18% seen by Wegmans Holdings Berhad over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared Wegmans Holdings Berhad's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 0.8% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Wegmans Holdings Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is Wegmans Holdings Berhad Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 25% (or a retention ratio of 75%) which is pretty normal, Wegmans Holdings 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. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Wegmans Holdings 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 consistent dividends even though earnings have been shrinking. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 33% over the next three years. However, Wegmans Holdings Berhad's future ROE is expected to rise to 15% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

On the whole, we feel that the performance shown by Wegmans Holdings Berhad can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the 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. To know the 4 risks we have identified for Wegmans Holdings Berhad visit our risks dashboard for free.

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