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Magna International Inc. (TSE:MG) Stock's On A Decline: Are Poor Fundamentals The Cause?

With its stock down 19% over the past three months, it is easy to disregard Magna International (TSE:MG). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Magna International's ROE.

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.

View our latest analysis for Magna International

How Is ROE Calculated?

The formula for return on equity is:

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Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Magna International is:

9.2% = US$1.1b ÷ US$12b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.09 in profit.

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Magna International's Earnings Growth And 9.2% ROE

When you first look at it, Magna International's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 9.5%, we may spare it some thought. But then again, Magna International's five year net income shrunk at a rate of 16%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 5.9% in the same 5-year period, we still found Magna International's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is MG worth today? The intrinsic value infographic in our free research report helps visualize whether MG is currently mispriced by the market.

Is Magna International Using Its Retained Earnings Effectively?

Magna International has a high three-year median payout ratio of 51% (that is, it is retaining 49% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, Magna International has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 26% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 15%, over the same period.

Conclusion

On the whole, Magna International's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.