Are Strong Financial Prospects The Force That Is Driving The Momentum In REDtone Digital Berhad's KLSE:REDTONE) Stock?

REDtone Digital Berhad (KLSE:REDTONE) has had a great run on the share market with its stock up by a significant 15% over the last week. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to REDtone Digital 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for REDtone Digital 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 REDtone Digital Berhad is:

12% = RM35m ÷ RM286m (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.12.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of REDtone Digital Berhad's Earnings Growth And 12% ROE

At first glance, REDtone Digital Berhad seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.9%. This certainly adds some context to REDtone Digital Berhad's exceptional 31% net income growth seen over the past five years. However, there could also be other causes behind this 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 REDtone Digital Berhad's growth is quite high when compared to the industry average growth of 25% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about REDtone Digital Berhad's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is REDtone Digital Berhad Efficiently Re-investing Its Profits?

REDtone Digital Berhad's three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like REDtone Digital Berhad is reinvesting its earnings efficiently.

Moreover, REDtone Digital Berhad is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

On the whole, we feel that REDtone Digital Berhad's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 2 risks we have identified for REDtone Digital Berhad.

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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.