Will CK Life Sciences Int’l (Holdings) Inc (HKG:775) Continue To Underperform Its Industry?
I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
CK Life Sciences Int’l (Holdings) Inc (HKG:775) delivered a less impressive 6.2% ROE over the past year, compared to the 12.5% return generated by its industry. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into 775’s past performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of 775’s returns.
See our latest analysis for CK Life Sciences Int’l. (Holdings)
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of CK Life Sciences Int’l. (Holdings)’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of CK Life Sciences Int’l. (Holdings)’s equity capital deployed. Its cost of equity is 17.3%. Given a discrepancy of -11.2% between return and cost, this indicated that CK Life Sciences Int’l. (Holdings) may be paying more for its capital than what it’s generating in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue CK Life Sciences Int’l. (Holdings) can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt CK Life Sciences Int’l. (Holdings) currently has. The debt-to-equity ratio currently stands at a balanced 105%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. CK Life Sciences Int’l. (Holdings)’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For CK Life Sciences Int’l. (Holdings), I’ve put together three fundamental aspects you should further examine:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does CK Life Sciences Int’l. (Holdings)’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of CK Life Sciences Int’l. (Holdings)? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
