With its stock down 48% over the past three months, it is easy to disregard LKL International Berhad (KLSE:LKL). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study LKL International Berhad's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 LKL International Berhad is:
2.9% = RM3.4m ÷ RM117m (Based on the trailing twelve months to January 2021).
The 'return' is the profit over the last twelve months. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.03.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
LKL International Berhad's Earnings Growth And 2.9% ROE
It is hard to argue that LKL International Berhad's ROE is much good in and of itself. Even compared to the average industry ROE of 65%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 20% seen by LKL International Berhad over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared LKL International Berhad's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 55% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is LKL International Berhad fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is LKL International Berhad Using Its Retained Earnings Effectively?
Because LKL International Berhad doesn't pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In total, we're a bit ambivalent about LKL International 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. 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. You can see the 5 risks we have identified for LKL International Berhad by visiting our risks dashboard for free on our platform here.
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