MEGAIN Holding (Cayman)'s (HKG:6939) stock is up by a considerable 17% over the past week. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. 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.
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for MEGAIN Holding (Cayman) is:
7.1% = CN¥22m ÷ CN¥305m (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.07 in profit.
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.
MEGAIN Holding (Cayman)'s Earnings Growth And 7.1% ROE
When you first look at it, MEGAIN Holding (Cayman)'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 10%. Therefore, it might not be wrong to say that the five year net income decline of 32% seen by MEGAIN Holding (Cayman) was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - 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 22% in the same period.
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 MEGAIN Holding (Cayman)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is MEGAIN Holding (Cayman) Making Efficient Use Of Its Profits?
When we piece together MEGAIN Holding (Cayman)'s low three-year median payout ratio of 17% (where it is retaining 83% 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. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.
In addition, MEGAIN Holding (Cayman) only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.
Overall, we have mixed feelings about MEGAIN Holding (Cayman). While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for MEGAIN Holding (Cayman) visit our risks dashboard for free.
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.