Should Weakness in Magic Software Enterprises Ltd.'s (NASDAQ:MGIC) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?
Magic Software Enterprises (NASDAQ:MGIC) has had a rough three months with its share price down 14%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Magic Software Enterprises' ROE in this article.
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 Magic Software Enterprises
How Do You Calculate Return On Equity?
Return on equity 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:
11% = US$35m ÷ US$306m (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.11 in profit.
Why Is ROE Important For 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 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 11% ROE
To start with, Magic Software Enterprises' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 11%. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Magic Software Enterprises.
As a next step, we compared Magic Software Enterprises' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 20% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Magic Software Enterprises fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Magic Software Enterprises Using Its Retained Earnings Effectively?
Magic Software Enterprises has a significant three-year median payout ratio of 81%, meaning that it is left with only 19% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Besides, Magic Software Enterprises has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.
Summary
Overall, we feel that Magic Software Enterprises certainly does have some positive factors to consider. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
