Magal Security Systems (NASDAQ:MAGS) has had a great run on the share market with its stock up by a significant 18% over the last three months. 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. Particularly, we will be paying attention to Magal Security Systems’ ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Magal Security Systems is:
3.5% = US$3.2m ÷ US$91m (Based on the trailing twelve months to September 2020).
The ‘return’ refers to a company’s earnings over the last year. That means that for every $1 worth of shareholders’ equity, the company generated $0.04 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. 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.
Magal Security Systems’ Earnings Growth And 3.5% ROE
As you can see, Magal Security Systems’ ROE looks pretty weak. Not just that, even compared to the industry average of 9.7%, the company’s ROE is entirely unremarkable. Magal Security Systems was still able to see a decent net income growth of 9.4% over the past five years. We believe that there might be other aspects that are positively influencing the company’s earnings 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.
We then performed a comparison between Magal Security Systems’ net income growth with the industry, which revealed that the company’s growth is similar to the average industry growth of 11% in the same period.
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. Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Magal Security Systems is trading on a high P/E or a low P/E, relative to its industry.
Is Magal Security Systems Efficiently Re-investing Its Profits?
In total, it does look like Magal Security Systems has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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. To know the 1 risk we have identified for Magal Security Systems visit our risks dashboard for free.
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This article by Simply Wall St is general in nature. 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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