Advertisement
U.S. markets close in 5 hours 53 minutes
  • S&P 500

    5,253.47
    +4.98 (+0.09%)
     
  • Dow 30

    39,774.81
    +14.73 (+0.04%)
     
  • Nasdaq

    16,407.24
    +7.71 (+0.05%)
     
  • Russell 2000

    2,120.68
    +6.33 (+0.30%)
     
  • Crude Oil

    82.37
    +1.02 (+1.25%)
     
  • Gold

    2,225.60
    +12.90 (+0.58%)
     
  • Silver

    24.67
    -0.08 (-0.33%)
     
  • EUR/USD

    1.0814
    -0.0015 (-0.14%)
     
  • 10-Yr Bond

    4.2080
    +0.0120 (+0.29%)
     
  • GBP/USD

    1.2645
    +0.0007 (+0.05%)
     
  • USD/JPY

    151.2520
    +0.0060 (+0.00%)
     
  • Bitcoin USD

    71,088.37
    +1,859.93 (+2.69%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,963.50
    +31.52 (+0.40%)
     
  • Nikkei 225

    40,168.07
    -594.66 (-1.46%)
     

Should We Be Cautious About Huaxi Holdings Company Limited’s (HKG:1689) ROE Of 9.4%?

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We’ll use ROE to examine Huaxi Holdings Company Limited (HKG:1689), by way of a worked example.

Over the last twelve months Huaxi Holdings has recorded a ROE of 9.4%. One way to conceptualize this, is that for each HK$1 of shareholders’ equity it has, the company made HK$0.094 in profit.

Check out our latest analysis for Huaxi Holdings

How Do You Calculate ROE?

The formula for return on equity is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Huaxi Holdings:

9.4% = HK$32m ÷ HK$334m (Based on the trailing twelve months to March 2018.)

It’s easy to understand the ‘net profit’ part of that equation, but ‘shareholders’ equity’ requires further explanation. It is all earnings retained by the company, plus any capital paid in by shareholders. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does Return On Equity Mean?

Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections). The ‘return’ is the amount earned after tax over the last twelve months. That means that the higher the ROE, the more profitable the company is. So, as a general rule, a high ROE is a good thing. Clearly, then, one can use ROE to compare different companies.

Does Huaxi Holdings Have A Good ROE?

By comparing a company’s ROE with its industry average, we can get a quick measure of how good it is. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. If you look at the image below, you can see Huaxi Holdings has a lower ROE than the average (13%) in the packaging industry classification.

SEHK:1689 Last Perf November 12th 18
SEHK:1689 Last Perf November 12th 18

That’s not what we like to see. We’d prefer see an ROE above the industry average, but it might not matter if the company is undervalued. Nonetheless, it might be wise to check if insiders have been selling.

The Importance Of Debt To Return On Equity

Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders’ equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Huaxi Holdings’s Debt And Its 9.4% ROE

One positive for shareholders is that Huaxi Holdings does not have any net debt! Even though I don’t think its ROE is that great, I think it’s very respectable when you consider it has no debt. After all, when a company has a strong balance sheet, it can often find ways to invest in growth, even if it takes some time.

The Bottom Line On ROE

Return on equity is one way we can compare the business quality of different companies. In my book the highest quality companies have high return on equity, despite low debt. All else being equal, a higher ROE is better.

Having said that, while ROE is a useful indicator of business quality, you’ll have to look at a whole range of factors to determine the right price to buy a stock. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. So I think it may be worth checking this free this detailed graph of past earnings, revenue and cash flow .

If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Advertisement