Magna International (TSE:MG) has had a rough month with its share price down 8.4%. We, however decided to study the company’s financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it’s worth paying close attention. Particularly, we will be paying attention to Magna International’s ROE today.
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 Magna International
How Do You 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 Magna International is:
9.3% = US$1.0b ÷ US$11b (Based on the trailing twelve months to September 2022).
The ‘return’ is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.09 in profit.
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.
Magna International’s Earnings Growth And 9.3% ROE
At first glance, Magna International’s ROE doesn’t look very promising. However, its ROE is similar to the industry average of 8.3%, so we won’t completely dismiss the company. But then again, Magna International’s five year net income shrunk at a rate of 19%. Bear in mind, the company does have a slightly low ROE. So that’s what might be causing earnings growth to shrink.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 11% in the same period, we still found Magna International’s performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you’re wondering about Magna International’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Magna International Making Efficient Use Of Its Profits?
In spite of a normal three-year median payout ratio of 42% (that is, a retention ratio of 58%), the fact that Magna International’s earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company’s business may be deteriorating.
Moreover, Magna International has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 22% over the next three years. As a result, the expected drop in Magna International’s payout ratio explains the anticipated rise in the company’s future ROE to 19%, over the same period.
Conclusion
On the whole, we feel that the performance shown by Magna International can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. 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.
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