What Implications Could This Have On The Stock?

MotorCycle Holdings’ (ASX:MTO) stock is up by a considerable 15% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don’t look very promising. Particularly, we will be paying attention to MotorCycle Holdings’ 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for MotorCycle Holdings

How To 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 MotorCycle Holdings is:

2.4% = AU$3.3m ÷ AU$139m (Based on the trailing twelve months to December 2020).

The ‘return’ refers to a company’s earnings over the last year. So, this means that for every A$1 of its shareholder’s investments, the company generates a profit of A$0.02.

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 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.

MotorCycle Holdings’ Earnings Growth And 2.4% ROE

As you can see, MotorCycle Holdings’ ROE looks pretty weak. Not just that, even compared to the industry average of 19%, the company’s ROE is entirely unremarkable. For this reason, MotorCycle Holdings’ five year net income decline of 19% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company’s earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared MotorCycle Holdings’ growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 6.8% in the same period. This is quite worrisome.

past-earnings-growth

past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. 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. What is MTO worth today? The intrinsic value infographic in our free research report helps visualize whether MTO is currently mispriced by the market.

Is MotorCycle Holdings Making Efficient Use Of Its Profits?

MotorCycle Holdings’ declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 65% (or a retention ratio of 35%). 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. You can see the 4 risks we have identified for MotorCycle Holdings by visiting our risks dashboard for free on our platform here.

In addition, MotorCycle Holdings has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 56%. Still, forecasts suggest that MotorCycle Holdings’ future ROE will rise to 13% even though the the company’s payout ratio is not expected to change by much.

Conclusion

Overall, we would be extremely cautious before making any decision on MotorCycle Holdings. Because the company is not reinvesting much into the business, and given the low ROE, it’s not surprising to see the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that analysts are forecasting a slight improvement in the company’s future earnings growth. Sure enough, this could bring some relief to shareholders. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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