With its stock down 2.5% over the past three months, it is easy to disregard XL Holdings Berhad (KLSE:XL). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on XL Holdings Berhad's ROE.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for XL Holdings Berhad

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 XL Holdings Berhad is:

0.7% = RM885k ÷ RM125m (Based on the trailing twelve months to October 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.01 in profit.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of XL Holdings Berhad's Earnings Growth And 0.7% ROE

It is quite clear that XL Holdings Berhad's ROE is rather low. Even when compared to the industry average of 10%, the ROE figure is pretty disappointing. Despite this, surprisingly, XL Holdings Berhad saw an exceptional 35% net income growth over the past five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared XL Holdings Berhad's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 18%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about XL Holdings Berhad's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is XL Holdings Berhad Using Its Retained Earnings Effectively?

XL Holdings Berhad doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

On the whole, we do feel that XL Holdings Berhad has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 2 risks we have identified for XL Holdings Berhad by visiting our risks dashboard for free on our platform here.

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.

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