Could The Market Be Wrong About Far East Holdings Berhad (KLSE:FAREAST) Given Its Attractive Financial Prospects?

With its stock down 3.4% over the past month, it is easy to disregard Far East Holdings Berhad (KLSE:FAREAST). 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. Particularly, we will be paying attention to Far East Holdings Berhad's 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Far East Holdings Berhad

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 Far East Holdings Berhad is:

18% = RM257m ÷ RM1.4b (Based on the trailing twelve months to September 2022).

The 'return' is the profit over the last twelve months. So, this means that for every MYR1 of its shareholder's investments, the company generates a profit of MYR0.18.

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 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 Far East Holdings Berhad's Earnings Growth And 18% ROE

To begin with, Far East Holdings Berhad seems to have a respectable ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This certainly adds some context to Far East Holdings Berhad's exceptional 22% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Far East Holdings Berhad's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Far East Holdings Berhad is trading on a high P/E or a low P/E, relative to its industry.

Is Far East Holdings Berhad Using Its Retained Earnings Effectively?

The three-year median payout ratio for Far East Holdings Berhad is 32%, which is moderately low. The company is retaining the remaining 68%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Far East Holdings Berhad is reinvesting its earnings efficiently.

Additionally, Far East Holdings Berhad 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

In total, we are pretty happy with Far East Holdings Berhad's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard will have the 1 risk we have identified for Far East Holdings Berhad.

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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