Do Its Financials Have Any Role To Play In Driving Magic Software Enterprises Ltd.'s (NASDAQ:MGIC) Stock Up Recently?

Most readers would already be aware that Magic Software Enterprises' (NASDAQ:MGIC) stock increased significantly by 19% over the past month. 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. Particularly, we will be paying attention to Magic Software Enterprises' 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.

See our latest analysis for Magic Software Enterprises

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 Magic Software Enterprises is:

10% = US$29m ÷ US$277m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.10 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. 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. 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.

Magic Software Enterprises' Earnings Growth And 10% ROE

To start with, Magic Software Enterprises' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Despite the modest returns, Magic Software Enterprises' five year net income growth was quite low, averaging at only 2.0%. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Magic Software Enterprises' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 30% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is MGIC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Magic Software Enterprises Making Efficient Use Of Its Profits?

Magic Software Enterprises has a three-year median payout ratio of 80% (implying that it keeps only 20% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Additionally, Magic Software Enterprises 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.

Summary

In total, it does look like Magic Software Enterprises has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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