Most readers would already know that Macmahon Holdings' (ASX:MAH) stock increased by 9.5% over the past three months. Given that the stock prices usually follow long-term business performance, we wonder if the company's mixed financials could have any adverse effect on its current price price movement Particularly, we will be paying attention to Macmahon Holdings' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Macmahon Holdings

How Is ROE Calculated?

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 Macmahon Holdings is:

8.4% = AU$53m ÷ AU$634m (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.08 in profit.

Why Is ROE Important For 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 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.

Macmahon Holdings' Earnings Growth And 8.4% ROE

On the face of it, Macmahon Holdings' ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 11%. As a result, Macmahon Holdings' flat net income growth over the past five years doesn't come as a surprise given its lower ROE.

As a next step, we compared Macmahon Holdings' net income growth with the industry and discovered that the industry saw an average growth of 21% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Macmahon Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Macmahon Holdings Making Efficient Use Of Its Profits?

Despite having a moderate three-year median payout ratio of 29% (meaning the company retains71% of profits) in the last three-year period, Macmahon Holdings' earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Macmahon Holdings has paid dividends over a period of five years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 25%. However, Macmahon Holdings' ROE is predicted to rise to 14% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we feel that the performance shown by Macmahon Holdings can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.