HK Asia Holdings (HKG:1723) has had a rough three months with its share price down 7.5%. 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 HK Asia 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
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 HK Asia Holdings is:
16% = HK$27m ÷ HK$165m (Based on the trailing twelve months to September 2019).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.16 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
HK Asia Holdings' Earnings Growth And 16% ROE
To begin with, HK Asia Holdings seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.4%. Needless to say, we are quite surprised to see that HK Asia Holdings' net income shrunk at a rate of 5.1% over the past five years. We reckon that there could be some other factors at play here that are preventing 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.
However, when we compared HK Asia Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.5% in the same period. This is quite worrisome.
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. This then helps them determine if the stock is placed for a bright or bleak future. Is HK Asia Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is HK Asia Holdings Using Its Retained Earnings Effectively?
HK Asia Holdings doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
On the whole, we do feel that HK Asia Holdings has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. 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. You can see the 3 risks we have identified for HK Asia Holdings by visiting our risks dashboard for free on our platform here.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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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