Are Poor Financial Prospects Dragging Down Bermaz Auto Berhad (KLSE:BAUTO Stock?

It is hard to get excited after looking at Bermaz Auto Berhad's (KLSE:BAUTO) recent performance, when its stock has declined 5.0% over the past week. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Bermaz Auto 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Bermaz Auto Berhad

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Bermaz Auto Berhad is:

12% = RM64m ÷ RM550m (Based on the trailing twelve months to October 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 MYR0.12.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Bermaz Auto Berhad's Earnings Growth And 12% ROE

When you first look at it, Bermaz Auto Berhad's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 9.7%, we may spare it some thought. But Bermaz Auto Berhad saw a five year net income decline of 4.3% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

With the industry earnings declining at a rate of 4.3% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Bermaz Auto Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is Bermaz Auto Berhad Using Its Retained Earnings Effectively?

Bermaz Auto Berhad's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 66% (or a retention ratio of 34%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 2 risks we have identified for Bermaz Auto Berhad by visiting our risks dashboard for free on our platform here.

In addition, Bermaz Auto Berhad has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 61% of its profits over the next three years. Still, forecasts suggest that Bermaz Auto Berhad's future ROE will rise to 27% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Bermaz Auto Berhad. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

If you decide to trade Bermaz Auto Berhad, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.