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Micro-Mechanics (Holdings) (SGX:5DD) has had a rough month with its share price down 8.2%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Micro-Mechanics (Holdings)'s ROE today.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Micro-Mechanics (Holdings)
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 Micro-Mechanics (Holdings) is:
18% = S$7.9m ÷ S$44m (Based on the trailing twelve months to March 2024).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.18 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Micro-Mechanics (Holdings)'s Earnings Growth And 18% ROE
To begin with, Micro-Mechanics (Holdings) seems to have a respectable ROE. On comparing with the average industry ROE of 8.4% the company's ROE looks pretty remarkable. Needless to say, we are quite surprised to see that Micro-Mechanics (Holdings)'s net income shrunk at a rate of 4.3% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.
However, when we compared Micro-Mechanics (Holdings)'s growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 16% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Micro-Mechanics (Holdings)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.