Malmbergs Elektriska's (STO:MEAB B) stock is up by a considerable 16% over the past month. 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 Malmbergs Elektriska'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Malmbergs Elektriska is:
12% = kr40m ÷ kr344m (Based on the trailing twelve months to September 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.12 in profit.
What Has ROE Got To Do With 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. 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.
A Side By Side comparison of Malmbergs Elektriska's Earnings Growth And 12% ROE
At first glance, Malmbergs Elektriska seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 19% does temper our expectations. Further research shows that Malmbergs Elektriska's net income has shrunk at a rate of 20% over the last five years. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. Therefore, the shrinking earnings could be the result of other factors. These include low earnings retention or poor allocation of capital.
So, as a next step, we compared Malmbergs Elektriska's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 15% in the same period.
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. Is Malmbergs Elektriska fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Malmbergs Elektriska Using Its Retained Earnings Effectively?
Malmbergs Elektriska has a high three-year median payout ratio of 51% (that is, it is retaining 49% 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. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 4 risks we have identified for Malmbergs Elektriska.
Additionally, Malmbergs Elektriska has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
In total, we're a bit ambivalent about Malmbergs Elektriska's performance. On the one hand, the company does have a decent rate of return, however, its earnings growth number is quite disappointing and as discussed earlier, the low retained earnings is hampering the growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Malmbergs Elektriska's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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.