Sunway Construction Group Berhad's (KLSE:SUNCON) stock is up by a considerable 7.2% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Sunway Construction Group Berhad's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Sunway Construction Group Berhad

How Is ROE Calculated?

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 Sunway Construction Group Berhad is:

17% = RM139m ÷ RM821m (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each MYR1 of shareholders' capital it has, the company made MYR0.17 in profit.

What Has ROE Got To Do With 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.

Sunway Construction Group Berhad's Earnings Growth And 17% ROE

To start with, Sunway Construction Group Berhad's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 4.4%. For this reason, Sunway Construction Group Berhad's five year net income decline of 3.4% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, we compared Sunway Construction Group Berhad's performance against the industry and found that the industry shrunk its earnings at 4.8% in the same period, which suggests that the company's earnings have been shrinking at a slower rate than its industry, This does appease the negative sentiment around the company to a certain extent.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is SUNCON fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sunway Construction Group Berhad Making Efficient Use Of Its Profits?

Sunway Construction Group Berhad has a high three-year median payout ratio of 66% (that is, it is retaining 34% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. 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 2 risks we have identified for Sunway Construction Group Berhad.

Moreover, Sunway Construction Group Berhad has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 57%. As a result, Sunway Construction Group Berhad's ROE is not expected to change by much either, which we inferred from the analyst estimate of 19% for future ROE.

Summary

Overall, we feel that Sunway Construction Group Berhad certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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