Lotus KFM Berhad's (KLSE:LOTUS) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at Lotus KFM Berhad's (KLSE:LOTUS) recent performance, when its stock has declined 14% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Lotus KFM Berhad's ROE in this article.

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.

View our latest analysis for Lotus KFM 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 Lotus KFM Berhad is:

18% = RM9.9m ÷ RM56m (Based on the trailing twelve months to September 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 MYR0.18 in profit.

Why Is ROE Important For 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. 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.

Lotus KFM Berhad's Earnings Growth And 18% ROE

To start with, Lotus KFM Berhad's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 6.9%. This probably laid the ground for Lotus KFM Berhad's significant 59% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

When you consider the fact that the industry earnings have shrunk at a rate of 6.0% in the same period, the company's net income growth is pretty remarkable.

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. 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 Lotus KFM Berhad's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Lotus KFM Berhad Making Efficient Use Of Its Profits?

Summary

In total, we are pretty happy with Lotus KFM Berhad'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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 2 risks we have identified for Lotus KFM Berhad by visiting our risks dashboard for free on our platform here.

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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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