Madkom SA's (WSE:MAD) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Madkom (WSE:MAD) has had a great run on the share market with its stock up by a significant 17% over the last week. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Madkom'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Madkom

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Madkom is:

11% = zł1.0m ÷ zł9.0m (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every PLN1 worth of equity, the company was able to earn PLN0.11 in profit.

What Has ROE Got To Do With 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Madkom's Earnings Growth And 11% ROE

At first glance, Madkom's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 20% either. Given the circumstances, the significant decline in net income by 3.6% seen by Madkom over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Madkom's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 21% in the same period. This is quite worrisome.

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 Madkom is trading on a high P/E or a low P/E, relative to its industry.

Is Madkom Using Its Retained Earnings Effectively?

Madkom doesn't pay any regular dividends, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Conclusion

In total, we're a bit ambivalent about Madkom's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 3 risks we have identified for Madkom.

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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.