Advanced Medical Solutions Group plc's (LON:AMS) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Advanced Medical Solutions Group (LON:AMS) has had a rough week with its share price down 4.4%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Advanced Medical Solutions Group'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Advanced Medical Solutions Group

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 Advanced Medical Solutions Group is:

7.0% = UK£14m ÷ UK£198m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.07 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. 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. 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.

Advanced Medical Solutions Group's Earnings Growth And 7.0% ROE

On the face of it, Advanced Medical Solutions Group's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 7.9%, we may spare it some thought. On the other hand, Advanced Medical Solutions Group reported a moderate 6.5% net income growth over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Advanced Medical Solutions Group's reported growth was lower than the industry growth of 27% in the same period, 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 AMS fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Advanced Medical Solutions Group Using Its Retained Earnings Effectively?

Advanced Medical Solutions Group's three-year median payout ratio to shareholders is 13% (implying that it retains 87% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Advanced Medical Solutions Group 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 19% over the next three years. Regardless, the future ROE for Advanced Medical Solutions Group is speculated to rise to 10% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

In total, it does look like Advanced Medical Solutions Group has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. 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.

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This article by Simply Wall St is general in nature. 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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