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Multi-Chem (SGX:AWZ) has had a great run on the share market with its stock up by a significant 14% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Multi-Chem's ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Multi-Chem
How To Calculate Return On Equity?
ROE 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 Multi-Chem is:
19% = S$27m ÷ S$144m (Based on the trailing twelve months to December 2023).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each SGD1 of shareholders' capital it has, the company made SGD0.19 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.
Multi-Chem's Earnings Growth And 19% ROE
At first glance, Multi-Chem seems to have a decent ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This probably laid the ground for Multi-Chem's significant 25% net income growth seen over the past 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 compared Multi-Chem's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.8% in the same 5-year period.
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. 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 Multi-Chem is trading on a high P/E or a low P/E, relative to its industry.