Could The Market Be Wrong About Magic Software Enterprises Ltd. (NASDAQ:MGIC) Given Its Attractive Financial Prospects?
With its stock down 7.2% over the past three months, it is easy to disregard Magic Software Enterprises (NASDAQ:MGIC). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Magic Software Enterprises' ROE in this article.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Magic Software Enterprises
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 Magic Software Enterprises is:
17% = US$47m ÷ US$269m (Based on the trailing twelve months to March 2023).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.17.
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.
A Side By Side comparison of Magic Software Enterprises' Earnings Growth And 17% ROE
At first glance, Magic Software Enterprises seems to have a decent ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. This certainly adds some context to Magic Software Enterprises' decent 19% net income growth seen over the past five years.
Next, on comparing Magic Software Enterprises' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 19% over the last few years.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Magic Software Enterprises fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Magic Software Enterprises Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 79% (or a retention ratio of 21%) for Magic Software Enterprises suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Additionally, Magic Software Enterprises has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.
Conclusion
Overall, we are quite pleased with Magic Software Enterprises' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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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.
