Micro-Mechanics (Holdings)'s (SGX:5DD) stock is up by a considerable 12% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Micro-Mechanics (Holdings)'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Micro-Mechanics (Holdings)

How To 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 Micro-Mechanics (Holdings) is:

21% = S$9.8m ÷ S$46m (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.21.

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. 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 Micro-Mechanics (Holdings)'s Earnings Growth And 21% ROE

To begin with, Micro-Mechanics (Holdings) seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 18%. Despite the modest returns, Micro-Mechanics (Holdings)'s five year net income growth was quite low, averaging at only 2.1%. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Micro-Mechanics (Holdings)'s net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 23% in the same 5-year period, which is a bit concerning.

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 Micro-Mechanics (Holdings) is trading on a high P/E or a low P/E, relative to its industry.

Is Micro-Mechanics (Holdings) Making Efficient Use Of Its Profits?

Micro-Mechanics (Holdings) has a three-year median payout ratio of 90% (implying that it keeps only 9.6% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Additionally, Micro-Mechanics (Holdings) has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

Overall, we have mixed feelings about Micro-Mechanics (Holdings). Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 2 risks we have identified for Micro-Mechanics (Holdings).

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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.