With its stock down 17% over the past three months, it is easy to disregard Karex Berhad (KLSE:KAREX). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Karex Berhad's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Karex Berhad
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 Karex Berhad is:
0.7% = RM3.1m ÷ RM467m (Based on the trailing twelve months to March 2023).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every MYR1 worth of equity, the company was able to earn MYR0.01 in profit.
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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Karex Berhad's Earnings Growth And 0.7% ROE
As you can see, Karex Berhad's ROE looks pretty weak. Even when compared to the industry average of 8.6%, the ROE figure is pretty disappointing. For this reason, Karex Berhad's five year net income decline of 53% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.
So, as a next step, we compared Karex Berhad's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.5% 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 Karex Berhad fairly valued compared to other companies? These 3 valuation measures might help you decide.