REDtone Digital Berhad's (KLSE:REDTONE) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

REDtone Digital Berhad's (KLSE:REDTONE) stock is up by a considerable 13% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to REDtone Digital 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for REDtone Digital Berhad

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for REDtone Digital Berhad is:

4.4% = RM7.3m ÷ RM165m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.04 in profit.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

REDtone Digital Berhad's Earnings Growth And 4.4% ROE

As you can see, REDtone Digital Berhad's ROE looks pretty weak. Even when compared to the industry average of 7.4%, the ROE figure is pretty disappointing. In spite of this, REDtone Digital Berhad was able to grow its net income considerably, at a rate of 60% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

When you consider the fact that the industry earnings have shrunk at a rate of 2.5% in the same period, the company's net income growth is pretty remarkable.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 REDtone Digital Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is REDtone Digital Berhad Efficiently Re-investing Its Profits?

The really high three-year median payout ratio of 230% for REDtone Digital Berhad suggests that the company is paying its shareholders more than what it is earning. In spite of this, the company was able to grow its earnings significantly, as we saw above. With that said, it could be worth keeping an eye on the high payout ratio as that's a huge risk. You can see the 5 risks we have identified for REDtone Digital Berhad by visiting our risks dashboard for free on our platform here.

Additionally, REDtone Digital Berhad has paid dividends over a period of eight years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

Overall, we have mixed feelings about REDtone Digital Berhad. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of REDtone Digital 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. 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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