Lumina Group Limited's (HKG:1162) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Lumina Group (HKG:1162) has had a great run on the share market with its stock up by a significant 66% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Lumina Group's 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.

View our latest analysis for Lumina Group

How Is ROE Calculated?

ROE 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 Lumina Group is:

6.9% = HK$9.5m ÷ HK$138m (Based on the trailing twelve months to September 2020).

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

Lumina Group's Earnings Growth And 6.9% ROE

When you first look at it, Lumina Group's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10% either. Although, we can see that Lumina Group saw a modest net income growth of 5.3% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Lumina Group's reported growth was lower than the industry growth of 13% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Lumina Group is trading on a high P/E or a low P/E, relative to its industry.

Is Lumina Group Using Its Retained Earnings Effectively?

Conclusion

In total, it does look like Lumina Group has some positive aspects to its business. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. 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 3 risks we have identified for Lumina Group.

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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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