Medicalgorithmics S.A.'s (WSE:MDG) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Medicalgorithmics' (WSE:MDG) stock is up by a considerable 22% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Medicalgorithmics' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Medicalgorithmics

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 Medicalgorithmics is:

6.2% = zł5.8m ÷ zł94m (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each PLN1 of shareholders' capital it has, the company made PLN0.06 in profit.

Why Is ROE Important For 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. 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 Medicalgorithmics' Earnings Growth And 6.2% ROE

On the face of it, Medicalgorithmics' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. Given the circumstances, the significant decline in net income by 22% seen by Medicalgorithmics over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Medicalgorithmics' 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 9.1% over the last few years.

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 Medicalgorithmics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Medicalgorithmics Making Efficient Use Of Its Profits?

Medicalgorithmics doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all 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.

Summary

On the whole, we feel that the performance shown by Medicalgorithmics can be open to many interpretations. 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 3 risks we have identified for Medicalgorithmics.

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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.