Sun Art Retail Group (HKG:6808) has had a great run on the share market with its stock up by a significant 34% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Sun Art Retail Group's 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To 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 Sun Art Retail Group is:
12% = CN¥3.0b ÷ CN¥25b (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.12 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Sun Art Retail Group's Earnings Growth And 12% ROE
At first glance, Sun Art Retail Group seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.1%. Despite this, Sun Art Retail Group's five year net income growth was quite flat over the past five years. 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. These include low earnings retention or poor allocation of capital.
As a next step, we compared Sun Art Retail Group's net income growth with the industry and discovered that the company's growth is slightly better than the industry which has shrunk at a rate of 0.5% 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. Has the market priced in the future outlook for 6808? You can find out in our latest intrinsic value infographic research report.
Is Sun Art Retail Group Making Efficient Use Of Its Profits?
In spite of a normal three-year median payout ratio of 47% (or a retention ratio of 53%), Sun Art Retail Group hasn't seen much growth in its earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Sun Art Retail Group has been paying dividends over a period of eight years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 39% of its profits over the next three years. Accordingly, forecasts suggest that Sun Art Retail Group's future ROE will be 13% which is again, similar to the current ROE.
In total, we are pretty happy with Sun Art Retail Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.
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