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Micro-Mechanics (Holdings) (SGX:5DD) has had a rough month with its share price down 8.3%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. 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. In this article, we decided to focus on Micro-Mechanics (Holdings)'s 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out 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:

17% = S$7.7m ÷ S$46m (Based on the trailing twelve months to December 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 SGD0.17.

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. 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 Micro-Mechanics (Holdings)'s Earnings Growth And 17% ROE

To start with, Micro-Mechanics (Holdings)'s ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. As you might expect, the 2.0% net income decline reported by Micro-Mechanics (Holdings) is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

That being said, we compared Micro-Mechanics (Holdings)'s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 28% in the same 5-year 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. 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 Micro-Mechanics (Holdings) is trading on a high P/E or a low P/E, relative to its industry.

Is Micro-Mechanics (Holdings) Efficiently Re-investing Its Profits?

Micro-Mechanics (Holdings)'s declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 91% (or a retention ratio of 9.2%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 3 risks we have identified for Micro-Mechanics (Holdings) by visiting our risks dashboard for free on our platform here.

Additionally, Micro-Mechanics (Holdings) has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

On the whole, we feel that the performance shown by Micro-Mechanics (Holdings) can be open to many interpretations. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Micro-Mechanics (Holdings)'s past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.