MEGAIN Holding (Cayman) Co., Ltd.'s (HKG:6939) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

MEGAIN Holding (Cayman)'s (HKG:6939) stock is up by a considerable 26% over the past three months. 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for MEGAIN Holding (Cayman)

How Do You Calculate Return On Equity?

Return on equity 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 MEGAIN Holding (Cayman) is:

6.3% = CN¥23m ÷ CN¥370m (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

MEGAIN Holding (Cayman)'s Earnings Growth And 6.3% ROE

When you first look at it, MEGAIN Holding (Cayman)'s ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 11% either. For this reason, MEGAIN Holding (Cayman)'s five year net income decline of 6.7% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared MEGAIN Holding (Cayman)'s performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 25% over the last few years.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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?

Looking at its three-year median payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, MEGAIN Holding (Cayman)'s declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, MEGAIN Holding (Cayman) has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, we're a bit ambivalent about MEGAIN Holding (Cayman)'s performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. Our risks dashboard would have the 4 risks we have identified for MEGAIN Holding (Cayman).

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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.