With its stock down 30% over the past three months, it is easy to disregard Allgens Medical Technology (SHSE:688613). 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 Allgens Medical Technology's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Allgens Medical Technology is:

5.8% = CN¥80m ÷ CN¥1.4b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Allgens Medical Technology's Earnings Growth And 5.8% ROE

At first glance, Allgens Medical Technology's ROE doesn't look very promising. Next, when compared to the average industry ROE of 9.3%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 9.6% net income growth seen by Allgens Medical Technology over the past five years is definitely a positive. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Allgens Medical Technology's reported growth was lower than the industry growth of 16% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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 Allgens Medical Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Allgens Medical Technology Making Efficient Use Of Its Profits?

Allgens Medical Technology has a low three-year median payout ratio of 22%, meaning that the company retains the remaining 78% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

While Allgens Medical Technology has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

On the whole, we do feel that Allgens Medical Technology has some positive attributes. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. 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. Our risks dashboard will have the 1 risk we have identified for Allgens Medical Technology.

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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.