Gamuda Berhad's (KLSE:GAMUDA) stock up by 6.8% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Gamuda Berhad's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Gamuda Berhad

How To Calculate Return On Equity?

ROE 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 Gamuda Berhad is:

6.9% = RM751m ÷ RM11b (Based on the trailing twelve months to April 2023).

The 'return' refers to a company's earnings over the last year. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.07 in profit.

What Is The Relationship Between ROE And 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.

Gamuda Berhad's Earnings Growth And 6.9% ROE

At first glance, Gamuda Berhad's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 4.1% which we definitely can't overlook. However, Gamuda Berhad's five year net income decline rate was 2.4%. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the shrinking earnings.

Next, we compared Gamuda Berhad's performance against the industry and found that the industry shrunk its earnings at 4.9% in the same period, which suggests that the company's earnings have been shrinking at a slower rate than its industry, While this is not particularly good, its not particularly bad either.

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. 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.