Most readers would already be aware that Sunway Construction Group Berhad's (KLSE:SUNCON) stock increased significantly by 12% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Sunway Construction Group Berhad's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Sunway Construction Group Berhad

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 Sunway Construction Group Berhad is:

15% = RM131m ÷ RM852m (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.15.

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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Sunway Construction Group Berhad's Earnings Growth And 15% ROE

To start with, Sunway Construction Group Berhad's ROE looks acceptable. Especially when compared to the industry average of 6.0% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for Sunway Construction Group Berhad in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

As a next step, we compared Sunway Construction Group Berhad's performance with the industry and discovered the industry has shrunk at a rate of 3.4% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. While this is not particularly good, its not particularly bad either.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for SUNCON? You can find out in our latest intrinsic value infographic research report.

Is Sunway Construction Group Berhad Using Its Retained Earnings Effectively?

Sunway Construction Group Berhad has a high three-year median payout ratio of 60% (or a retention ratio of 40%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Moreover, Sunway Construction Group Berhad has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 51%. Still, forecasts suggest that Sunway Construction Group Berhad's future ROE will rise to 19% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we do feel that Sunway Construction Group Berhad has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.