Most readers would already be aware that Hung Fook Tong Group Holdings' (HKG:1446) stock increased significantly by 18% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Hung Fook Tong Group Holdings' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Hung Fook Tong Group Holdings is:
3.8% = HK$10m ÷ HK$272m (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.04.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Hung Fook Tong Group Holdings' Earnings Growth And 3.8% ROE
At first glance, Hung Fook Tong Group Holdings' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 6.4% either. Despite this, surprisingly, Hung Fook Tong Group Holdings saw an exceptional 56% net income growth over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Hung Fook Tong Group Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 1.7%.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Hung Fook Tong Group Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Hung Fook Tong Group Holdings Efficiently Re-investing Its Profits?
Hung Fook Tong Group Holdings has a three-year median payout ratio of 26% (where it is retaining 74% of its income) which is not too low or not too high. So it seems that Hung Fook Tong Group Holdings is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Besides, Hung Fook Tong Group Holdings has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders.
Overall, we feel that Hung Fook Tong Group Holdings certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its 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. Our risks dashboard would have the 2 risks we have identified for Hung Fook Tong Group Holdings.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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