Declining Stock and Decent Financials: Is The Market Wrong About Shanghai Kindly Medical Instruments Co., Ltd. (HKG:1501)?

It is hard to get excited after looking at Shanghai Kindly Medical Instruments' (HKG:1501) recent performance, when its stock has declined 21% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Shanghai Kindly Medical Instruments' ROE today.

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.

View our latest analysis for Shanghai Kindly Medical Instruments

How Do You 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 Shanghai Kindly Medical Instruments is:

9.0% = CN¥115m ÷ CN¥1.3b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.09.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Shanghai Kindly Medical Instruments' Earnings Growth And 9.0% ROE

On the face of it, Shanghai Kindly Medical Instruments' ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 9.6%, we may spare it some thought. Looking at Shanghai Kindly Medical Instruments' exceptional 33% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. 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.

Next, on comparing with the industry net income growth, we found that Shanghai Kindly Medical Instruments' growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Shanghai Kindly Medical Instruments is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Kindly Medical Instruments Using Its Retained Earnings Effectively?

Shanghai Kindly Medical Instruments has a really low three-year median payout ratio of 22%, meaning that it has the remaining 78% left over to reinvest into its business. So it looks like Shanghai Kindly Medical Instruments is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Along with seeing a growth in earnings, Shanghai Kindly Medical Instruments only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Conclusion

Overall, we feel that Shanghai Kindly Medical Instruments certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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