Challenger Technologies (SGX:573) has had a rough three months with its share price down 6.4%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Challenger Technologies' ROE today.

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 Challenger Technologies

How Is ROE Calculated?

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 Challenger Technologies is:

8.5% = S$13m ÷ S$155m (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of Challenger Technologies' Earnings Growth And 8.5% ROE

On the face of it, Challenger Technologies' ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 10%, we may spare it some thought. We can see that Challenger Technologies has grown at a five year net income growth average rate of 3.9%, which is a bit on the lower side. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

We then compared Challenger Technologies' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 5.7% in the same period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Challenger Technologies fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Challenger Technologies Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 40% (or a retention ratio of 60% over the past three years, Challenger Technologies has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Challenger Technologies has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that the performance shown by Challenger Technologies can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for Challenger Technologies visit our risks dashboard for free.

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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