Is the recent price movement of FSM Holdings Limited (HKG:1721) supported by its weak fundamentals?
With its stock down 32% in the past three months, it’s easy to overlook FSM Holdings (HKG: 1721). It’s possible that the markets ignored the company’s financial differences and decided to look into the negative sentiment. Stock prices are usually determined by a company’s financial performance over the long term, and so we decided to pay more attention to the company’s financial performance. Specifically, we decided to study the ROE of FSM Holdings in this article.
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
Check out our latest analysis for FSM Holdings
How to calculate return on equity?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for FSM Holdings is:
2.8% = S$977,000 ÷ S$34m (based on trailing 12 months to June 2022).
The “return” is the annual profit. So this means that for every HK$1 of investment by its shareholder, the company generates a profit of HK$0.03.
What does ROE have to do with earnings growth?
So far, we have learned that ROE measures how efficiently a company generates its profits. Depending on how much of its profits the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and better earnings retention are generally the ones with a higher growth rate compared to companies that don’t. same characteristics.
A side-by-side comparison of FSM Holdings’ earnings growth and 2.8% ROE
As you can see, FSM Holdings’ ROE looks quite weak. Even compared to the industry average ROE of 6.9%, the company’s ROE is pretty dismal. Given the circumstances, the significant drop in net profit of 73% seen by FSM Holdings over the past five years is not surprising. However, there could also be other factors leading to lower income. Such as – low income retention or poor capital allocation.
So, as a next step, we benchmarked FSM Holdings’ performance against the industry and were disappointed to find that while the company was cutting earnings, the industry was increasing earnings at a rate of 9.9 % over the same period.
The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. If you’re wondering about the valuation of FSM Holdings, check out this indicator of its price-earnings ratio, relative to its sector.
Does FSM Holdings effectively reinvest its earnings?
FSM Holdings pays no dividends, which means the company keeps all of its profits, which makes us wonder why it keeps its profits if it can’t use them to grow its business. So there could be other factors at play here that could potentially impede growth. For example, the company had to deal with headwinds.
Overall, we believe that the performance displayed by FSM Holdings is open to many interpretations. Although the company has a high reinvestment rate, the low ROE means that all this reinvestment does not benefit its investors and, moreover, it has a negative impact on earnings growth. In conclusion, we would proceed with caution with this business and one way to do that would be to review the risk profile of the business. Our risk dashboard would have the 2 risks we identified for FSM Holdings.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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