With its stock down 4.5% over the past month, it is easy to disregard MHM Automation (NZSE:MHM). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study MHM Automation's ROE in this article.
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.
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 MHM Automation is:
24% = NZ$1.1m ÷ NZ$4.9m (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.24.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
MHM Automation's Earnings Growth And 24% ROE
First thing first, we like that MHM Automation has an impressive ROE. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. Under the circumstances, MHM Automation's considerable five year net income growth of 35% was to be expected.
Next, on comparing with the industry net income growth, we found that MHM Automation's growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about MHM Automation's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is MHM Automation Making Efficient Use Of Its Profits?
In total, we are pretty happy with MHM Automation's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. You can see the 3 risks we have identified for MHM Automation by visiting our risks dashboard for free on our platform here.
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