With its stock down 2.8% over the past three months, it is easy to disregard Multi-Chem (SGX:AWZ). 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 Multi-Chem'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Multi-Chem is:
15% = S$20m ÷ S$127m (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.15 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Multi-Chem's Earnings Growth And 15% ROE
At first glance, Multi-Chem seems to have a decent ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This probably laid the ground for Multi-Chem's moderate 12% net income growth seen over the past five years.
Given that the industry shrunk its earnings at a rate of 4.7% in the same period, the net income growth of the company is quite impressive.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Multi-Chem is trading on a high P/E or a low P/E, relative to its industry.
Is Multi-Chem Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 38% (implying that the company retains 62% of its profits), it seems that Multi-Chem is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Moreover, Multi-Chem is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.
On the whole, we feel that Multi-Chem's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 2 risks we have identified for Multi-Chem visit our risks dashboard for free.
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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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