It is hard to get excited after looking at Sejong Medical’s (KOSDAQ:258830) recent performance, when its stock has declined 21% over the past three months. 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 Sejong Medical’s ROE today.
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?
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 Sejong Medical is:
5.6% = ₩2.5b ÷ ₩45b (Based on the trailing twelve months to June 2020).
The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each ₩1 of shareholders’ capital it has, the company made ₩0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
Sejong Medical’s Earnings Growth And 5.6% ROE
It is hard to argue that Sejong Medical’s ROE is much good in and of itself. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. However, the moderate 9.0% net income growth seen by Sejong Medical over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. Such as – high earnings retention or an efficient management in place.
Next, on comparing Sejong Medical’s net income growth with the industry, we found that the company’s reported growth is similar to the industry average growth rate of 8.3% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Sejong Medical is trading on a high P/E or a low P/E, relative to its industry.
Is Sejong Medical Making Efficient Use Of Its Profits?
Sejong Medical has a low three-year median payout ratio of 21%, meaning that the company retains the remaining 79% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
While Sejong Medical has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.
In total, it does look like Sejong Medical 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. 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 would have the 4 risks we have identified for Sejong Medical.
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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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