Most readers would already know that Magna International’s (TSE:MG) stock increased by 3.4% over the past week. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Particularly, we will be paying attention to Magna International’s ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
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:
4.2% = US$479m ÷ US$11b (Based on the trailing twelve months to March 2023).
The ‘return’ refers to a company’s earnings over the last year. That means that for every CA$1 worth of shareholders’ equity, the company generated CA$0.04 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. 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.
Magna International’s Earnings Growth And 4.2% ROE
On the face of it, Magna International’s ROE is not much to talk about. We then compared the company’s ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 7.8%. Given the circumstances, the significant decline in net income by 24% seen by Magna International over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
As a next step, we compared Magna International’s performance with the industry and found thatMagna International’s performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 10% in the same period, which is a slower than the company.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. Is MG fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is Magna International Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 51% (implying that 49% of the profits are retained), most of Magna International’s profits are being paid to shareholders, which explains the company’s shrinking earnings. The business is only left with a small pool of capital to reinvest – A vicious cycle that doesn’t benefit the company in the long-run. Our risks dashboard should have the 3 risks we have identified for Magna International.
Additionally, Magna International has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 25% over the next three years. The fact that the company’s ROE is expected to rise to 17% over the same period is explained by the drop in the payout ratio.
Summary
Overall, we would be extremely cautious before making any decision on Magna International. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company’s earnings growth rate. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here