Which way is the stock going?

Most readers already know that shares of KPJ Healthcare Berhad (KLSE:KPJ) are up 4.3% in the last three months. However, we decided to study the company’s mixed fundamentals to assess what it could mean for future share prices, since share prices are often aligned with a company’s long-term financial performance. Specifically, we decided to study KPJ Healthcare Berhad’s ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures a company’s profitability relative to its shareholders’ equity.

See our latest analysis for KPJ Healthcare Berhad

How to calculate return on equity?

Return on equity can be calculated using the formula:

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

So, based on the above formula, the ROE for KPJ Healthcare Berhad is:

9.8% = RM238mil, RM2.4bil (based on trailing twelve months to June 2023).

The ‘return’ is the amount you have earned after taxes over the past twelve months. One way to conceptualize this is that for every MYR1 of shareholder capital it has, the company has made MYR0.10 in profit.

What does ROE have to do with earnings growth?

So far we’ve learned that ROE is a measure of a company’s profitability. Based on how much of its profits the company decides to reinvest or “retain”, we can then evaluate a company’s future ability to generate profits. 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 have these characteristics.

KPJ Healthcare Berhad earnings growth and 9.8% ROE

At first glance, KPJ Healthcare Berhad’s ROE doesn’t look promising. We then compared the company’s ROE with the broader industry and were disappointed to see that the ROE was lower than the industry average of 13%. Given the circumstances, the significant 8.3% decline in net income that KPJ Healthcare Berhad has seen over the past five years is not surprising. We think that other factors may also play a role here. For example, the company has a very high payout ratio, or is facing competitive pressure.

The story continues

So as a next step, we compared KPJ Healthcare Berhad’s performance with that of the industry. We were disappointed to discover that while the company has been cutting back on earnings, the industry has grown earnings by 31% in recent years.

The basis for assigning value to a company is largely linked to profit growth. It is important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This then helps them determine whether the stock has a bright or bleak future. What is KPJ worth today? The intrinsic value infographic in our free research report helps visualize whether KPJ is currently mispriced by the market.

Is KPJ Healthcare Berhad using its profits efficiently?

Despite a normal three-year average payout ratio of 45% (i.e. a 55% retention ratio), the fact that KPJ Healthcare Berhad’s revenues have shrunk is quite confusing. Other factors may therefore play a role that could potentially hinder growth. For example, the company has faced headwinds.

Furthermore, KPJ Healthcare Berhad has paid dividends for at least a decade, meaning the company’s management is committed to paying dividends even if it means little to no earnings growth. Our latest analyst data shows that the company’s future payout ratio is expected to rise to 54% over the next three years. Either way, ROE isn’t expected to change much for the company, despite the higher expected payout ratio.

Resume

Overall, we’re a bit ambivalent about KPJ Healthcare Berhad’s performance. Even though the company appears to be retaining most of its profits given its low ROE, investors may not benefit from all that reinvestment. The low earnings growth indicates that our theory is correct. That said, we looked at the latest analyst forecasts and found that while the company has shrunk its profits in the past, analysts expect profits to grow in the future. To learn more about the latest analyst forecasts for the company, check this out visualization of analyst forecasts for the company.

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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. We aim to provide you with targeted, long-term analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Simply Wall St has no positions in the stocks mentioned.