Kinovo plc's (LON:KINO) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

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Most readers would already be aware that Kinovo’s (LON:KINO) stock increased significantly by 24% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company’s key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Kinovo’s ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder’s equity.

Check out our latest analysis for Kinovo

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Kinovo is:

12% = UK£1.4m ÷ UK£11m (Based on the trailing twelve months to September 2021).

The ‘return’ is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.

A Side By Side comparison of Kinovo’s Earnings Growth And 12% ROE

To begin with, Kinovo seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. As you might expect, the 11% net income decline reported by Kinovo is a bit of a surprise. Based on this, we feel that there might be other reasons which haven’t been discussed so far in this article that could be hampering the company’s growth. These include low earnings retention or poor allocation of capital.

That being said, we compared Kinovo’s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 13% in the same period.

past-earnings-growth

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. If you’re wondering about Kinovo’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Kinovo Efficiently Re-investing Its Profits?

Kinovo’s low LTM (or last twelve month) payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company’s business may be deteriorating.

In addition, Kinovo has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

Overall, we feel that Kinovo certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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. To know the 3 risks we have identified for Kinovo visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.