EKF Diagnostics Holdings plc (LON:EKF) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Most readers would already be aware that EKF Diagnostics Holdings' (LON:EKF) stock increased significantly by 24% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on EKF Diagnostics Holdings' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for EKF Diagnostics Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for EKF Diagnostics Holdings is:

8.4% = UK£6.6m ÷ UK£79m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.08 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

EKF Diagnostics Holdings' Earnings Growth And 8.4% ROE

When you first look at it, EKF Diagnostics Holdings' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.9%. Moreover, we are quite pleased to see that EKF Diagnostics Holdings' net income grew significantly at a rate of 61% over the last five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared EKF Diagnostics Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 27%.

Earnings growth is an important metric to consider when valuing a stock. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if EKF Diagnostics Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is EKF Diagnostics Holdings Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 90% (implying that it keeps only 9.5% of profits) for EKF Diagnostics Holdings suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 58% over the next three years.

Conclusion

On the whole, we feel that the performance shown by EKF Diagnostics Holdings can be open to many interpretations. While no doubt its earnings growth is pretty substantial, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, especially during troubled times. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink 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. 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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