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

Mikro MSC Berhad's (KLSE:MIKROMB) stock is up by a considerable 7.1% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Particularly, we will be paying attention to Mikro MSC Berhad's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Mikro MSC Berhad

How Do You 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 Mikro MSC Berhad is:

4.0% = RM3.9m ÷ RM98m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.04 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Mikro MSC Berhad's Earnings Growth And 4.0% ROE

It is quite clear that Mikro MSC Berhad's ROE is rather low. Even compared to the average industry ROE of 7.9%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 24% seen by Mikro MSC Berhad was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Mikro MSC Berhad's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 2.0% in the same period.

Earnings growth is a huge factor in stock valuation. 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 Mikro MSC Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is Mikro MSC Berhad Efficiently Re-investing Its Profits?

Mikro MSC Berhad has a high three-year median payout ratio of 54% (that is, it is retaining 46% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for Mikro MSC Berhad visit our risks dashboard for free.

Moreover, Mikro MSC 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.

Summary

Overall, we would be extremely cautious before making any decision on Mikro MSC Berhad. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Up till now, we've only made a short study of the company's growth data. You can do your own research on Mikro MSC 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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