Can N2N Connect Berhad's (KLSE:N2N) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Most readers would already be aware that N2N Connect Berhad's (KLSE:N2N) stock increased significantly by 19% over the past month. 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. Particularly, we will be paying attention to N2N Connect Berhad's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for N2N Connect Berhad

How Is ROE Calculated?

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 N2N Connect Berhad is:

6.3% = RM18m ÷ RM281m (Based on the trailing twelve months to March 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every MYR1 worth of equity, the company was able to earn MYR0.06 in profit.

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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

N2N Connect Berhad's Earnings Growth And 6.3% ROE

At first glance, N2N Connect Berhad's ROE doesn't look very promising. Next, when compared to the average industry ROE of 8.6%, the company's ROE leaves us feeling even less enthusiastic. Accordingly, N2N Connect Berhad's low net income growth of 3.2% over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared N2N Connect Berhad's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 17% in the same period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 N2N Connect Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is N2N Connect Berhad Using Its Retained Earnings Effectively?

N2N Connect Berhad has a three-year median payout ratio of 52% (implying that it keeps only 48% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Additionally, N2N Connect Berhad has paid dividends over a period of nine years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 66% over the next three years.

Summary

Overall, we would be extremely cautious before making any decision on N2N Connect Berhad. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.