With its stock down 37% over the past three months, it is easy to disregard Guangzhou Kingmed Diagnostics Group (SHSE:603882). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Guangzhou Kingmed Diagnostics Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You Calculate Return On Equity?

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 Guangzhou Kingmed Diagnostics Group is:

5.6% = CN¥470m ÷ CN¥8.4b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated 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. 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.

A Side By Side comparison of Guangzhou Kingmed Diagnostics Group's Earnings Growth And 5.6% ROE

At first glance, Guangzhou Kingmed Diagnostics Group's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.4%, so we won't completely dismiss the company. Having said that, Guangzhou Kingmed Diagnostics Group has shown a modest net income growth of 18% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Guangzhou Kingmed Diagnostics Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.2%.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Guangzhou Kingmed Diagnostics Group is trading on a high P/E or a low P/E, relative to its industry.

Is Guangzhou Kingmed Diagnostics Group Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that Guangzhou Kingmed Diagnostics Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Guangzhou Kingmed Diagnostics Group has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 51% over the next three years. Still, forecasts suggest that Guangzhou Kingmed Diagnostics Group's future ROE will rise to 12% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

In total, it does look like Guangzhou Kingmed Diagnostics Group has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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.

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