Gamuda Berhad (KLSE:GAMUDA) has had a great run on the share market with its stock up by a significant 5.1% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Gamuda Berhad's ROE.
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 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?
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 Gamuda Berhad is:
6.0% = RM682m ÷ RM11b (Based on the trailing twelve months to October 2022).
The 'return' is the profit over the last twelve months. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.06.
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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Gamuda Berhad's Earnings Growth And 6.0% ROE
When you first look at it, Gamuda Berhad's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.0%. Having said that, Gamuda Berhad's five year net income decline rate was 10%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.
As a next step, we compared Gamuda Berhad's performance with the industry and found thatGamuda Berhad's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 2.9% in the same period, which is a slower than the company.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Gamuda Berhad's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Gamuda Berhad Making Efficient Use Of Its Profits?
In spite of a normal three-year median payout ratio of 42% (that is, a retention ratio of 58%), the fact that Gamuda Berhad's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Gamuda Berhad has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 39% of its profits over the next three years. Still, forecasts suggest that Gamuda Berhad's future ROE will rise to 7.5% even though the the company's payout ratio is not expected to change by much.
In total, we're a bit ambivalent about Gamuda Berhad's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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.
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