Are Pacific Hospital Supply Co., Ltd's (GTSM:4126) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 5.7% over the past month, it is easy to disregard Pacific Hospital Supply (GTSM:4126). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Pacific Hospital Supply's ROE in this article.

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.

See our latest analysis for Pacific Hospital Supply

How Is ROE Calculated?

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 Pacific Hospital Supply is:

19% = NT$473m ÷ NT$2.5b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.19 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Pacific Hospital Supply's Earnings Growth And 19% ROE

To begin with, Pacific Hospital Supply seems to have a respectable ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. Yet, Pacific Hospital Supply has posted measly growth of 3.3% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Pacific Hospital Supply's reported growth was lower than the industry growth of 10% in the same period, which is not something we like to see.

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. Is 4126 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Pacific Hospital Supply Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 70% (or a retention ratio of 30%), most of Pacific Hospital Supply's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Additionally, Pacific Hospital Supply has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 92% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 15%, over the same period.

Conclusion

On the whole, we do feel that Pacific Hospital Supply has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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