Is Weakness In Modern Living Investments Holdings Limited (HKG:8426) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Modern Living Investments Holdings' (HKG:8426) recent performance, when its stock has declined 9.5% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Modern Living Investments 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Modern Living Investments Holdings

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Modern Living Investments Holdings is:

16% = HK$18m ÷ HK$117m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.16 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. 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. 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 Modern Living Investments Holdings' Earnings Growth And 16% ROE

To start with, Modern Living Investments Holdings' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.6%. Probably as a result of this, Modern Living Investments Holdings was able to see an impressive net income growth of 26% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings 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.

As a next step, we compared Modern Living Investments 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 17%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Modern Living Investments Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Modern Living Investments Holdings Using Its Retained Earnings Effectively?

Modern Living Investments Holdings has a three-year median payout ratio of 44% (where it is retaining 56% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Modern Living Investments Holdings is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

While Modern Living Investments Holdings has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, we are pretty happy with Modern Living Investments Holdings' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 2 risks we have identified for Modern Living Investments Holdings by visiting our risks dashboard for free on our platform here.

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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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