With its stock down 8.2% over the past three months, it is easy to disregard Ajiya Berhad (KLSE:AJIYA). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Ajiya Berhad'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Ajiya Berhad
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 Ajiya Berhad is:
15% = RM71m ÷ RM472m (Based on the trailing twelve months to February 2023).
The 'return' is the yearly profit. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.15 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Ajiya Berhad's Earnings Growth And 15% ROE
To begin with, Ajiya Berhad seems to have a respectable ROE. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. This certainly adds some context to Ajiya Berhad's exceptional 25% net income growth seen over the past five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Ajiya Berhad's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 23% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is Ajiya Berhad fairly valued compared to other companies? These 3 valuation measures might help you decide.