Cowealth Medical ChinaLtd (SHSE:603122) has had a rough three months with its share price down 24%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Cowealth Medical ChinaLtd's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Cowealth Medical ChinaLtd is:

6.2% = CN¥73m ÷ CN¥1.2b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.06 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Cowealth Medical ChinaLtd's Earnings Growth And 6.2% ROE

When you first look at it, Cowealth Medical ChinaLtd's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 7.9%. Thus, the low net income growth of 2.9% seen by Cowealth Medical ChinaLtd over the past five years could probably be the result of the low ROE.

We then compared Cowealth Medical ChinaLtd's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.0% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is 603122 worth today? The intrinsic value infographic in our free research report helps visualize whether 603122 is currently mispriced by the market.

Is Cowealth Medical ChinaLtd Using Its Retained Earnings Effectively?

Cowealth Medical ChinaLtd has a three-year median payout ratio of 74% (implying that it keeps only 26% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Cowealth Medical ChinaLtd only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Conclusion

On the whole, Cowealth Medical ChinaLtd's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. You can see the 2 risks we have identified for Cowealth Medical ChinaLtd by visiting our risks dashboard for free on our platform here.

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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.