Weak Financial Prospects Seem To Be Dragging Down LMS Compliance Ltd. (Catalist:LMS) Stock

LMS Compliance (Catalist:LMS) has had a rough three months with its share price down 10%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study LMS Compliance's ROE in this article.

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.

View our latest analysis for LMS Compliance

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 LMS Compliance is:

2.5% = RM706k ÷ RM29m (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. That means that for every SGD1 worth of shareholders' equity, the company generated SGD0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

LMS Compliance's Earnings Growth And 2.5% ROE

It is hard to argue that LMS Compliance's ROE is much good in and of itself. Even when compared to the industry average of 17%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 40% seen by LMS Compliance over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

However, when we compared LMS Compliance's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about LMS Compliance's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is LMS Compliance Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 56% (implying that 44% of the profits are retained), most of LMS Compliance's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 6 risks we have identified for LMS Compliance by visiting our risks dashboard for free on our platform here.

Additionally, LMS Compliance started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Summary

Overall, we would be extremely cautious before making any decision on LMS Compliance. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on LMS Compliance and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.