Is The Market Rewarding EKF Diagnostics Holdings plc (LON:EKF) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

It is hard to get excited after looking at EKF Diagnostics Holdings' (LON:EKF) recent performance, when its stock has declined 12% over the past month. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on EKF Diagnostics Holdings' ROE.

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. 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 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:

7.3% = UK£5.1m ÷ UK£70m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 7.3% 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 8.3%. But EKF Diagnostics Holdings saw a five year net income decline of 31% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

However, when we compared EKF Diagnostics Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 1.9% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is EKF Diagnostics Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is EKF Diagnostics Holdings Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 31% (where it is retaining 69% of its profits), EKF Diagnostics Holdings has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, EKF Diagnostics Holdings has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

On the whole, we feel that the performance shown by EKF Diagnostics Holdings can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for EKF Diagnostics Holdings visit our risks dashboard for free.

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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.