Yahoo Finance China Tobacco International (HK) Company Limited's (HKG:6055) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?
With its stock down 13% over the past three months, it is easy to disregard China Tobacco International (HK) (HKG:6055). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study China Tobacco International (HK)'s 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for China Tobacco International (HK)
How Do You Calculate Return On Equity?
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 China Tobacco International (HK) is:
20% = HK$319m ÷ HK$1.6b (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.20 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. 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. 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.
China Tobacco International (HK)'s Earnings Growth And 20% ROE
To begin with, China Tobacco International (HK) seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.5%. For this reason, China Tobacco International (HK)'s five year net income decline of 11% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. 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 China Tobacco International (HK)'s 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 2.4% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 China Tobacco International (HK) is trading on a high P/E or a low P/E, relative to its industry.
Is China Tobacco International (HK) Efficiently Re-investing Its Profits?
In spite of a normal three-year median payout ratio of 30% (that is, a retention ratio of 70%), the fact that China Tobacco International (HK)'s earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
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 36%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 19%.
Conclusion
In total, it does look like China Tobacco International (HK) has some positive aspects to its business. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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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