Civmec Limited's (SGX:P9D) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Civmec (SGX:P9D) has had a great run on the share market with its stock up by a significant 18% over the last week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Civmec's ROE.

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.

View our latest analysis for Civmec

How To Calculate Return On Equity?

The formula for return on equity is:

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

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

6.7% = AU$18m ÷ AU$263m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. That means that for every SGD1 worth of shareholders' equity, the company generated SGD0.07 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Civmec's Earnings Growth And 6.7% ROE

When you first look at it, Civmec's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 3.5% which we definitely can't overlook. But then again, seeing that Civmec's net income shrunk at a rate of 18% in the past five years, makes us think again. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the shrinking earnings.

We then compared Civmec's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 24% in the same period. This does offer shareholders some relief

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). Doing so will help them establish if the stock's future looks promising or ominous. 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 Civmec is trading on a high P/E or a low P/E, relative to its industry.

Is Civmec Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 36% (that is, a retention ratio of 64%), the fact that Civmec's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Civmec has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, it does look like Civmec has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Civmec.

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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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