Multi-Chem (SGX:AWZ) has had a rough three months with its share price down 5.1%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Multi-Chem's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Multi-Chem

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:

16% = S$22m ÷ S$139m (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.16.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Multi-Chem's Earnings Growth And 16% ROE

To start with, Multi-Chem's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. Probably as a result of this, Multi-Chem was able to see an impressive net income growth of 27% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then compared Multi-Chem's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 7.8% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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.