Can Straco Corporation Limited's (SGX:S85) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Most readers would already be aware that Straco's (SGX:S85) stock increased significantly by 16% over the past month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Straco's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Straco

How Is ROE Calculated?

Return on equity 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 Straco is:

1.8% = S$4.5m ÷ S$254m (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each SGD1 of shareholders' capital it has, the company made SGD0.02 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 Straco's Earnings Growth And 1.8% ROE

It is hard to argue that Straco's ROE is much good in and of itself. Even when compared to the industry average of 6.5%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 57% seen by Straco was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 9.5% over the last few years, we found that Straco's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Straco fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Straco Using Its Retained Earnings Effectively?

Straco has a high three-year median payout ratio of 56% (that is, it is retaining 44% 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. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 2 risks we have identified for Straco.

Additionally, Straco 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.

Conclusion

On the whole, Straco's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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 Straco'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. 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.