MCS Services Limited's (ASX:MSG) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 24% over the past three months, it is easy to disregard MCS Services (ASX:MSG). 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. In this article, we decided to focus on MCS Services' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for MCS Services

How Do You 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 MCS Services is:

43% = AU$1.5m ÷ AU$3.4m (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.43 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. 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.

A Side By Side comparison of MCS Services' Earnings Growth And 43% ROE

Firstly, we acknowledge that MCS Services has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 7.0% also doesn't go unnoticed by us. So, the substantial 67% net income growth seen by MCS Services over the past five years isn't overly surprising.

As a next step, we compared MCS Services' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.3%.

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. If you're wondering about MCS Services''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is MCS Services Using Its Retained Earnings Effectively?

Given that MCS Services doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

In total, we are pretty happy with MCS Services' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 2 risks we have identified for MCS Services.

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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.