China Medical System Holdings Limited's (HKG:867) Recent Stock Performance Looks Decent- Can Strong Fundamentals Be the Reason?

China Medical System Holdings' (HKG:867) stock up by 7.6% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to China Medical System Holdings' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for China Medical System Holdings

How Is ROE Calculated?

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 China Medical System Holdings is:

21% = CN¥3.4b ÷ CN¥16b (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.21.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of China Medical System Holdings' Earnings Growth And 21% ROE

To begin with, China Medical System Holdings seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 13%. This probably laid the ground for China Medical System Holdings' moderate 14% net income growth seen over the past five years.

As a next step, we compared China Medical System Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.6%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 China Medical System Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is China Medical System Holdings Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 40% (implying that the company retains 60% of its profits), it seems that China Medical System Holdings is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, China Medical System Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 28% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

In total, we are pretty happy with China Medical System Holdings' 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.