Justin Allen Holdings Limited's (HKG:1425) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 17% over the past three months, it is easy to disregard Justin Allen Holdings (HKG:1425). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Justin Allen Holdings' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Justin Allen Holdings

How To Calculate Return On Equity?

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 Justin Allen Holdings is:

25% = HK$107m ÷ HK$423m (Based on the trailing twelve months to June 2021).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.25 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Justin Allen Holdings' Earnings Growth And 25% ROE

Firstly, we acknowledge that Justin Allen Holdings has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 7.7% also doesn't go unnoticed by us. As a result, Justin Allen Holdings' exceptional 22% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Justin Allen Holdings compares quite favourably to the industry average, which shows a decline of 5.1% in the same period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is 1425 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Justin Allen Holdings Efficiently Re-investing Its Profits?

The three-year median payout ratio for Justin Allen Holdings is 41%, which is moderately low. The company is retaining the remaining 59%. So it seems that Justin Allen Holdings is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

While Justin Allen Holdings has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Summary

On the whole, we feel that Justin Allen Holdings' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 2 risks we have identified for Justin Allen Holdings.

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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.