Has MEGAIN Holding (Cayman) Co., Ltd.'s (HKG:6939) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Most readers would already be aware that MEGAIN Holding (Cayman)'s (HKG:6939) stock increased significantly by 43% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on MEGAIN Holding (Cayman)'s ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for MEGAIN Holding (Cayman)

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for MEGAIN Holding (Cayman) is:

13% = CN¥44m ÷ CN¥337m (Based on the trailing twelve months to June 2022).

The 'return' is the profit 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$0.13.

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. 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 MEGAIN Holding (Cayman)'s Earnings Growth And 13% ROE

At first glance, MEGAIN Holding (Cayman) seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. However, while MEGAIN Holding (Cayman) has a pretty respectable ROE, its five year net income decline rate was 20% . Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

That being said, we compared MEGAIN Holding (Cayman)'s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 18% 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. 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 MEGAIN Holding (Cayman) is trading on a high P/E or a low P/E, relative to its industry.

Is MEGAIN Holding (Cayman) Using Its Retained Earnings Effectively?

When we piece together MEGAIN Holding (Cayman)'s low three-year median payout ratio of 21% (where it is retaining 79% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

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

Summary

Overall, we feel that MEGAIN Holding (Cayman) certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 6 risks we have identified for MEGAIN Holding (Cayman) visit our risks dashboard for free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.