Are Straco Corporation Limited’s (SGX:S85) mixed financial results the reason for its poor stock market performance?

Straco (SGX:S85) has had a tough three months, with its share price down 4.2%. It looks like the market may have completely ignored the positive aspects of the company’s fundamentals and decided to focus more on the negatives. Long-term fundamentals tend to drive market performance, so it’s worth paying close attention to them. In this article, we decided to take a closer look at Straco’s ROE.

ROE or Return on Equity is a useful tool to assess how effectively a company can generate returns on the investment it has received from its shareholders. In simple terms, it is used to assess the profitability of a company in relation to its equity.

Check out our latest analysis for Straco

How is ROE calculated?

This return on equity formula Is:

Return on Equity = Net Profit (from continuing operations) ÷ Equity

Therefore, based on the above formula, the ROE for Straco is:

10% = SGD27 million ÷ SGD272 million (Based on the trailing twelve months to December 2023).

The ‘return’ refers to the company’s profits over the last year. One way to think of this is that for every SGD1 of shareholders’ capital, the company made SGD0.10 in profits.

Why does ROE matter for profit growth?

We have already established that ROE serves as an effective profit-generating indicator of a company’s future earnings. Based on how much of its earnings a company chooses to reinvest or “retain,” we are able to assess the company’s future ability to generate earnings. Generally speaking, assuming other factors are equal, companies with high ROE and profit retention have higher growth rates than companies that do not share these characteristics.

Straco Profit Growth and 10% ROE Comparison

When you look at it, Straco’s ROE doesn’t look too attractive. However, the fact that the company’s ROE is higher than the industry average ROE of 7.5% is definitely interesting. But on the other hand, seeing that Straco’s net income has shrunk by 46% over the last five years makes us think again. Remember, the company’s ROE is a bit low to begin with, it’s just higher than the industry average. Therefore, the decline in earnings could also be a result of that.

However, when we compared Straco’s growth with the industry, we found that while the company’s profits were shrinking, the industry saw profits grow by 12% during the same period. This is quite disturbing.

Earnings growth is a huge factor in stock valuation. Investors need to determine whether the expected earnings growth, or lack thereof, is already priced into the stock. This will give them an idea of ​​whether the stock is headed for clear blue waters or if it’s headed for a quagmire. If you’re wondering about Straco’s valuation, check out this price-to-earnings ratio compared to its industry.

The story continues

Does Straco effectively reinvest its profits?

Straco’s declining earnings are not surprising, given how the company spends most of its profits on paying dividends, judging by its three-year median payout of 56% (or a retention rate of 44%). The company has only a small pool of capital to reinvest – a vicious cycle that does not benefit the company in the long term. You can see 2 risks we have identified for Straco by visiting our Risk Table for free on our platform here.

In addition, Straco has been paying dividends for at least ten years, which means that the company’s management is committed to paying dividends even if it means little or no growth in profits.

Abstract

Overall, we think Straco’s results can be interpreted in a number of ways. First and foremost, we’re disappointed by the lack of earnings growth, even despite the moderate ROE. It’s important to remember that the company reinvests a small portion of its earnings, which explains the lack of growth. So far, we’ve only scratched the surface of the company’s past performance by looking at its fundamentals. For more on Straco’s past earnings growth, check out this visualization of past earnings, revenue, and cash flow.

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This Simply Wall St article is for general information purposes only. Our commentary is based solely on historical data and analyst forecasts, and is based on an objective methodology. Our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamental data. Please note that our analysis may not reflect the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.