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Most readers would already be aware that EKF Diagnostics Holdings' (LON:EKF) stock increased significantly by 49% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study EKF Diagnostics Holdings' 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 Is ROE Calculated?
ROE 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 EKF Diagnostics Holdings is:
5.5% = UK£3.9m ÷ UK£71m (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
EKF Diagnostics Holdings' Earnings Growth And 5.5% ROE
On the face of it, EKF Diagnostics Holdings' ROE is not much to talk about. 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 11%. Despite this, surprisingly, EKF Diagnostics Holdings saw an exceptional 57% net income growth over the past five years. 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 EKF Diagnostics Holdings' growth is quite high when compared to the industry average growth of 36% in the same period, which is great to see.
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). Doing so will help them establish if the stock's future looks promising or ominous. Is EKF Diagnostics Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is EKF Diagnostics Holdings Efficiently Re-investing Its Profits?
EKF Diagnostics Holdings' very high three-year median payout ratio of 123% suggests that the company is paying more to its shareholders than what it is earning. However, this hasn't hampered its ability to grow as we saw earlier. Having said that, the high payout ratio is definitely risky and something to keep an eye on. You can see the 4 risks we have identified for EKF Diagnostics Holdings by visiting our risks dashboard for free on our platform here.
Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 77% over the next three years.
Overall, we have mixed feelings about EKF Diagnostics Holdings. While no doubt its earnings growth is pretty substantial, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, especially during troubled times. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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