Should Weakness in LGMS Berhad's (KLSE:LGMS) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

LGMS Berhad (KLSE:LGMS) has had a rough month with its share price down 23%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to LGMS Berhad's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for LGMS 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 LGMS Berhad is:

14% = RM12m ÷ RM89m (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.14.

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. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

LGMS Berhad's Earnings Growth And 14% ROE

To begin with, LGMS Berhad seems to have a respectable ROE. Especially when compared to the industry average of 9.7% the company's ROE looks pretty impressive. This certainly adds some context to LGMS Berhad's decent 12% net income growth seen over the past five years.

As a next step, we compared LGMS Berhad's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 31% in the same period.

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

Is LGMS Berhad Using Its Retained Earnings Effectively?

LGMS Berhad has a significant three-year median payout ratio of 57%, meaning that it is left with only 43% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

While LGMS Berhad has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

Overall, we feel that LGMS Berhad certainly does have some positive factors to consider. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of LGMS Berhad's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.