It is hard to get excited after looking at Magna International’s (TSE:MG) recent performance, when its stock has declined 9.0% over the past three months. 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 Magna International’s ROE in this article.
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 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 Magna International
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 Magna International is:
8.9% = US$1.1b ÷ US$12b (Based on the trailing twelve months to June 2024).
The ‘return’ is the profit over the last twelve months. So, this means that for every CA$1 of its shareholder’s investments, the company generates a profit of CA$0.09.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
Magna International’s Earnings Growth And 8.9% ROE
On the face of it, Magna International’s ROE is not much to talk about. However, its ROE is similar to the industry average of 9.0%, so we won’t completely dismiss the company. But then again, Magna International’s five year net income shrunk at a rate of 11%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 4.0% in the same 5-year period, we still found Magna International’s performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
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). This then helps them determine if the stock is placed for a bright or bleak future. Is Magna International fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Magna International Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 53% (implying that 47% 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.
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 31% 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 14%, over the same period.
Conclusion
In total, we would have a hard think before deciding on any investment action concerning Magna International. 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.