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Magic Software Enterprises (NASDAQ:MGIC) has had a great run on the share market with its stock up by a significant 17% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Magic Software Enterprises' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Magic Software Enterprises
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 Magic Software Enterprises is:
13% = US$40m ÷ US$305m (Based on the trailing twelve months to September 2024).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.13.
Why Is ROE Important For 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 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.
Magic Software Enterprises' Earnings Growth And 13% ROE
To begin with, Magic Software Enterprises seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 12%. Consequently, this likely laid the ground for the impressive net income growth of 20% seen over the past five years by Magic Software Enterprises. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Magic Software Enterprises' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 18% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Magic Software Enterprises is trading on a high P/E or a low P/E, relative to its industry.