Chemclin Diagnostics Co., Ltd.'s (SHSE:688468) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

With its stock down 20% over the past month, it is easy to disregard Chemclin Diagnostics (SHSE:688468). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Chemclin Diagnostics' ROE.

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.

See our latest analysis for Chemclin Diagnostics

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 Chemclin Diagnostics is:

11% = CN¥151m ÷ CN¥1.4b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.11.

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 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.

A Side By Side comparison of Chemclin Diagnostics' Earnings Growth And 11% ROE

To start with, Chemclin Diagnostics' ROE looks acceptable. Especially when compared to the industry average of 7.4% the company's ROE looks pretty impressive. Despite this, Chemclin Diagnostics' five year net income growth was quite low averaging at only 3.0%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that Chemclin Diagnostics' reported growth was lower than the industry growth of 6.5% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Chemclin Diagnostics fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Chemclin Diagnostics Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 48% (implying that the company retains the remaining 52% of its income), Chemclin Diagnostics' earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Only recently, Chemclin Diagnostics started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth.

Conclusion

In total, it does look like Chemclin Diagnostics has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Chemclin Diagnostics.

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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.