Should Weakness in Beauty Farm Medical and Health Industry Inc.'s (HKG:2373) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at Beauty Farm Medical and Health Industry's (HKG:2373) recent performance, when its stock has declined 12% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Beauty Farm Medical and Health Industry's 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.

View our latest analysis for Beauty Farm Medical and Health Industry

How Is ROE Calculated?

Return on equity 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 Beauty Farm Medical and Health Industry is:

29% = CN¥212m ÷ CN¥740m (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.29 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. 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. 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.

A Side By Side comparison of Beauty Farm Medical and Health Industry's Earnings Growth And 29% ROE

Firstly, we acknowledge that Beauty Farm Medical and Health Industry has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. However, we are curious as to how the high returns still resulted in a flat growth for Beauty Farm Medical and Health Industry in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that Beauty Farm Medical and Health Industry's reported growth was lower than the industry growth of 1.7% over the last few years, which is not something we like to see.

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. 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 Beauty Farm Medical and Health Industry is trading on a high P/E or a low P/E, relative to its industry.

Is Beauty Farm Medical and Health Industry Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 46% (meaning the company retains54% of profits) in the last three-year period, Beauty Farm Medical and Health Industry's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Beauty Farm Medical and Health Industry only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 0.8% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 45%, over the same period.

Summary

Overall, we feel that Beauty Farm Medical and Health Industry certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.