Most readers would already know that EKF Diagnostics Holdings' (LON:EKF) stock increased by 8.8% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. In this article, we decided to focus on EKF Diagnostics Holdings' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for return on equity 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.
Why Is ROE Important For 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
EKF Diagnostics Holdings' Earnings Growth And 8.4% ROE
On the face of it, EKF Diagnostics Holdings' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.7%. 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. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared EKF Diagnostics Holdings' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 30% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Making Efficient Use Of 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.
Along with seeing a growth in earnings, EKF Diagnostics Holdings only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 55% over the next three years.
Overall, we have mixed feelings about EKF Diagnostics Holdings. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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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EKF Diagnostics Holdings
EKF Diagnostics Holdings plc designs, develops, manufactures, and sells diagnostic instruments, reagents, and other ancillary products in Europe, the Middle East, the Americas, Asia, Africa, and internationally.
Flawless balance sheet and undervalued.