Pecca Group Berhad's (KLSE:PECCA) stock is up by a considerable 13% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Pecca Group Berhad's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Pecca Group Berhad

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Pecca Group Berhad is:

18% = RM40m ÷ RM219m (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every MYR1 worth of equity, the company was able to earn MYR0.18 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. 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.

A Side By Side comparison of Pecca Group Berhad's Earnings Growth And 18% ROE

To start with, Pecca Group Berhad's ROE looks acceptable. On comparing with the average industry ROE of 7.2% the company's ROE looks pretty remarkable. Probably as a result of this, Pecca Group Berhad was able to see an impressive net income growth of 24% over the last five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then performed a comparison between Pecca Group Berhad's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 24% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Pecca Group Berhad is trading on a high P/E or a low P/E, relative to its industry.