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With its stock down 24% over the past three months, it is easy to disregard MCS Services (ASX:MSG). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on MCS Services' 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.
Check out our latest analysis for MCS Services
How Do You Calculate Return On Equity?
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 MCS Services is:
43% = AU$1.5m ÷ AU$3.4m (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.43 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
A Side By Side comparison of MCS Services' Earnings Growth And 43% ROE
Firstly, we acknowledge that MCS Services has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 7.0% also doesn't go unnoticed by us. So, the substantial 67% net income growth seen by MCS Services over the past five years isn't overly surprising.
As a next step, we compared MCS Services' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.3%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about MCS Services''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is MCS Services Using Its Retained Earnings Effectively?
Given that MCS Services doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.