MLOptic (SHSE:688502) has had a rough three months with its share price down 24%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study MLOptic's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How To Calculate Return On Equity?

Return on equity 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 MLOptic is:

3.1% = CN¥37m ÷ CN¥1.2b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.03 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of MLOptic's Earnings Growth And 3.1% ROE

It is hard to argue that MLOptic's ROE is much good in and of itself. Even compared to the average industry ROE of 6.3%, the company's ROE is quite dismal. Therefore, the disappointing ROE therefore provides a background to MLOptic's very little net income growth of 2.3% over the past five years.

We then compared MLOptic's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.2% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 MLOptic is trading on a high P/E or a low P/E, relative to its industry.

Is MLOptic Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 49% (or a retention ratio of 51% over the past three years, MLOptic has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, MLOptic only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Summary

In total, we're a bit ambivalent about MLOptic's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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.