Declining Stock and Decent Financials: Is The Market Wrong About N2N Connect Berhad (KLSE:N2N)?

N2N Connect Berhad (KLSE:N2N) has had a rough week with its share price down 11%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study N2N Connect Berhad's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for N2N Connect Berhad

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 N2N Connect Berhad is:

10% = RM27m ÷ RM263m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.10.

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. 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 10% ROE

At first glance, N2N Connect Berhad's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 11%, we may spare it some thought. Even so, N2N Connect Berhad has shown a fairly decent growth in its net income which grew at a rate of 10%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that N2N Connect Berhad's growth is quite high when compared to the industry average growth of 7.1% in the same period, which is great to see.

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. 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?

The high three-year median payout ratio of 68% (or a retention ratio of 32%) for N2N Connect Berhad suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, N2N Connect Berhad has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 63%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 8.7%.

Summary

In total, it does look like N2N Connect Berhad has some positive aspects to its business. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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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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