Stella International Holdings Limited's (HKG:1836) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?
It is hard to get excited after looking at Stella International Holdings' (HKG:1836) recent performance, when its stock has declined 20% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Stella International Holdings' ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
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How To 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 Stella International Holdings is:
10.0% = US$96m ÷ US$959m (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.10 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learnt that ROE is a measure of a company's profitability. 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.
Stella International Holdings' Earnings Growth And 10.0% ROE
At first glance, Stella International Holdings seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 8.8%. However, while Stella International Holdings has a pretty respectable ROE, its five year net income decline rate was 12% . 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. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
So, as a next step, we compared Stella International Holdings' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 3.8% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is 1836 worth today? The intrinsic value infographic in our free research report helps visualize whether 1836 is currently mispriced by the market.
Is Stella International Holdings Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 78% (implying that 22% of the profits are retained), most of Stella International Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 2 risks we have identified for Stella International Holdings.
Additionally, Stella International Holdings has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 76% of its profits over the next three years. Regardless, the future ROE for Stella International Holdings is predicted to rise to 13% despite there being not much change expected in its payout ratio.
Summary
On the whole, we do feel that Stella International Holdings has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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. 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. Thank you for reading.
