K W Nelson Interior Design and Contracting Group Limited's (HKG:8411) Stock Is Going Strong: Is the Market Following Fundamentals?

K W Nelson Interior Design and Contracting Group (HKG:8411) has had a great run on the share market with its stock up by a significant 14% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on K W Nelson Interior Design and Contracting Group'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for K W Nelson Interior Design and Contracting Group

How Do You Calculate Return On Equity?

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 K W Nelson Interior Design and Contracting Group is:

13% = HK$18m ÷ HK$141m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 K W Nelson Interior Design and Contracting Group's Earnings Growth And 13% ROE

To start with, K W Nelson Interior Design and Contracting Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 11%. This certainly adds some context to K W Nelson Interior Design and Contracting Group's exceptional 26% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared K W Nelson Interior Design and Contracting Group's 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 19% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about K W Nelson Interior Design and Contracting Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is K W Nelson Interior Design and Contracting Group Using Its Retained Earnings Effectively?

K W Nelson Interior Design and Contracting Group's three-year median payout ratio to shareholders is 8.6%, which is quite low. This implies that the company is retaining 91% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, K W Nelson Interior Design and Contracting Group is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Conclusion

Overall, we are quite pleased with K W Nelson Interior Design and Contracting Group's performance. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 2 risks we have identified for K W Nelson Interior Design and Contracting Group visit our risks dashboard for free.

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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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