Should Weakness in LGMS Berhad's (KLSE:LGMS) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at LGMS Berhad's (KLSE:LGMS) recent performance, when its stock has declined 11% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on LGMS Berhad's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for LGMS Berhad

How Is ROE Calculated?

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 LGMS Berhad is:

13% = RM11m ÷ RM83m (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.13.

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.

LGMS Berhad's Earnings Growth And 13% ROE

At first glance, LGMS Berhad seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 18% does temper our expectations. However, the moderate 13% net income growth seen by LGMS Berhad over the past five years is definitely a positive. So, there might be other aspects that are positively influencing earnings growth. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also provides some context to the earnings growth seen by the company.

As a next step, we compared LGMS Berhad's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 26% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is LGMS Berhad fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is LGMS Berhad Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 76% (or a retention ratio of 24%) for LGMS Berhad suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Along with seeing a growth in earnings, LGMS Berhad only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Conclusion

In total, it does look like LGMS Berhad has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely achieved by the company reinvesting its earnings at a decent rate of return. Still, its earnings retention is quite low, so we wonder if the company's growth could be higher, were it to pay out less dividends and retain more of its profits? That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.