Guanze Medical Information Industry (Holding) Co., Ltd.'s (HKG:2427) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Guanze Medical Information Industry (Holding) (HKG:2427) has had a great run on the share market with its stock up by a significant 94% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Guanze Medical Information Industry (Holding)'s ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Guanze Medical Information Industry (Holding)

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 Guanze Medical Information Industry (Holding) is:

7.4% = CN¥19m ÷ CN¥258m (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.07.

What Is The Relationship Between ROE And 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. 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.

Guanze Medical Information Industry (Holding)'s Earnings Growth And 7.4% ROE

When you first look at it, Guanze Medical Information Industry (Holding)'s ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.6%. Therefore, it might not be wrong to say that the five year net income decline of 8.4% seen by Guanze Medical Information Industry (Holding) was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared Guanze Medical Information Industry (Holding)'s growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Guanze Medical Information Industry (Holding) is trading on a high P/E or a low P/E, relative to its industry.

Is Guanze Medical Information Industry (Holding) Making Efficient Use Of Its Profits?

Guanze Medical Information Industry (Holding)'s declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 83% (or a retention ratio of 17%). With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 4 risks we have identified for Guanze Medical Information Industry (Holding).

Only recently, Guanze Medical Information Industry (Holding) stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Summary

On the whole, Guanze Medical Information Industry (Holding)'s performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Guanze Medical Information Industry (Holding)'s past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.