Classic Scenic Berhad's (KLSE:CSCENIC) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Classic Scenic Berhad's (KLSE:CSCENIC) stock is up by a considerable 72% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Classic Scenic Berhad's ROE.

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

View our latest analysis for Classic Scenic Berhad

How Do You Calculate Return On Equity?

Return on equity 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 Classic Scenic Berhad is:

4.5% = RM4.2m ÷ RM93m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.04.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of Classic Scenic Berhad's Earnings Growth And 4.5% ROE

It is quite clear that Classic Scenic Berhad's ROE is rather low. An industry comparison shows that the company's ROE is not much different from the industry average of 4.2% either. Therefore, it might not be wrong to say that the five year net income decline of 20% seen by Classic Scenic Berhad was possibly a result of the disappointing ROE.

Next, on comparing with the industry net income growth, we found that Classic Scenic Berhad's earnings seems to be shrinking at a similar rate as the industry which shrunk at a rate of a rate of 19% in the same period.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Classic Scenic Berhad's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Classic Scenic Berhad Using Its Retained Earnings Effectively?

Classic Scenic Berhad's very high three-year median payout ratio of 108% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. You can see the 4 risks we have identified for Classic Scenic Berhad by visiting our risks dashboard for free on our platform here.

Moreover, Classic Scenic 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.

Conclusion

On the whole, Classic Scenic Berhad's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Classic Scenic Berhad and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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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