Is Kawan Food Berhad's (KLSE:KAWAN) Recent Price Movement Underpinned By Its Weak Fundamentals?

Kawan Food Berhad (KLSE:KAWAN) has had a rough three months with its share price down 26%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Kawan Food 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.

Check out our latest analysis for Kawan Food Berhad

How Do You Calculate Return On Equity?

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 Kawan Food Berhad is:

7.8% = RM27m ÷ RM339m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.08 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.

Kawan Food Berhad's Earnings Growth And 7.8% ROE

On the face of it, Kawan Food Berhad's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 6.9%, we may spare it some thought. Having said that, Kawan Food Berhad's five year net income decline rate was 13%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 6.0% in the same period, we still found Kawan Food Berhad's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Kawan Food Berhad's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Kawan Food Berhad Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 39% (that is, a retention ratio of 61%), the fact that Kawan Food Berhad's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Kawan Food 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 43%. However, Kawan Food Berhad's ROE is predicted to rise to 12% despite there being no anticipated change in its payout ratio.

Summary

In total, we're a bit ambivalent about Kawan Food Berhad's performance. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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