Li Kang Biomedical (GTSM:6242) has had a rough three months with its share price down 1.6%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Li Kang Biomedical's ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Li Kang Biomedical is:
13% = NT$60m ÷ NT$477m (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.13 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Li Kang Biomedical's Earnings Growth And 13% ROE
To begin with, Li Kang Biomedical seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. Despite the modest returns, Li Kang Biomedical's five year net income growth was quite low, averaging at only 4.8%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.
We then compared Li Kang Biomedical's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 9.1% in the same period, which is a bit concerning.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Li Kang Biomedical is trading on a high P/E or a low P/E, relative to its industry.
Is Li Kang Biomedical Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 72% (that is, the company retains only 28% of its income) over the past three years for Li Kang Biomedical suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Additionally, Li Kang Biomedical has paid dividends over a period of five years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
Overall, we feel that Li Kang Biomedical 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. 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. 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 2 risks we have identified for Li Kang Biomedical visit our risks dashboard for free.
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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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