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Declining Stock and Decent Financials: Is The Market Wrong About Magic Software Enterprises Ltd. (NASDAQ:MGIC)?

Simply Wall St
·3-min read

With its stock down 19% over the past month, it is easy to disregard Magic Software Enterprises (NASDAQ:MGIC). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Magic Software Enterprises' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Magic Software Enterprises

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Magic Software Enterprises is:

15% = US$43m ÷ US$290m (Based on the trailing twelve months to September 2022).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.15.

What Is The Relationship Between ROE And Earnings Growth?

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

Magic Software Enterprises' Earnings Growth And 15% ROE

At first glance, Magic Software Enterprises seems to have a decent ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. This certainly adds some context to Magic Software Enterprises' decent 15% net income growth seen over the past five years.

As a next step, we compared Magic Software Enterprises' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 22% in the same period.

past-earnings-growth
past-earnings-growth

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). Doing so will help them establish if the stock's future looks promising or ominous. Is Magic Software Enterprises fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Magic Software Enterprises Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 81% (or a retention ratio of 19%) for Magic Software Enterprises suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Magic Software Enterprises is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

In total, it does look like Magic Software Enterprises has some positive aspects to its business. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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