Declining Stock and Decent Financials: Is The Market Wrong About Yum China Holdings, Inc. (NYSE:YUMC)?
With its stock down 12% over the past week, it is easy to disregard Yum China Holdings (NYSE:YUMC). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Yum China Holdings' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Yum China Holdings
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 Yum China Holdings is:
13% = US$901m ÷ US$7.1b (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.13 in profit.
What Has ROE Got 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 chooses to reinvest or "retain", we are then able to 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 bear these characteristics.
A Side By Side comparison of Yum China Holdings' Earnings Growth And 13% ROE
To begin with, Yum China Holdings seems to have a respectable ROE. Even so, when compared with the average industry ROE of 18%, we aren't very excited. Additionally, the low net income growth of 2.8% seen by Yum China Holdings over the past five years doesn't paint a very bright picture. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings growth to be low. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
We then compared Yum China Holdings' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 22% in the same 5-year period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is YUMC worth today? The intrinsic value infographic in our free research report helps visualize whether YUMC is currently mispriced by the market.
Is Yum China Holdings Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 26% (or a retention ratio of 74% over the past three years, Yum China Holdings has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Yum China Holdings has been paying dividends over a period of six years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 26%. However, Yum China Holdings' ROE is predicted to rise to 15% despite there being no anticipated change in its payout ratio.
Summary
Overall, we feel that Yum China Holdings certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
