With its stock down 2.2% over the past month, it is easy to disregard VSTECS Berhad (KLSE:VSTECS). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to VSTECS Berhad's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for VSTECS Berhad

How Do You 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 VSTECS Berhad is:

15% = RM65m ÷ RM428m (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.15 in profit.

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 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.

VSTECS Berhad's Earnings Growth And 15% ROE

To start with, VSTECS Berhad's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. This probably laid the ground for VSTECS Berhad's significant 22% net income growth seen over the past five years. 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.

We then performed a comparison between VSTECS Berhad's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 22% in the same 5-year 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 VSTECS Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is VSTECS Berhad Efficiently Re-investing Its Profits?

VSTECS Berhad's three-year median payout ratio is a pretty moderate 34%, meaning the company retains 66% of its income. So it seems that VSTECS Berhad is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, VSTECS Berhad is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

In total, we are pretty happy with VSTECS Berhad's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 2 risks we have identified for VSTECS Berhad.

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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.