Cathay Financial Holding Co., Ltd.'s (TWSE:2882) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Cathay Financial Holding (TWSE:2882) has had a great run on the share market with its stock up by a significant 10% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Cathay Financial Holding's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Cathay Financial Holding

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 Cathay Financial Holding is:

6.4% = NT$52b ÷ NT$801b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.06 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. 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.

Cathay Financial Holding's Earnings Growth And 6.4% ROE

When you first look at it, Cathay Financial Holding's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.7%. Given the circumstances, the significant decline in net income by 2.4% seen by Cathay Financial Holding over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared Cathay Financial Holding's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.0% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Cathay Financial Holding fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Cathay Financial Holding Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 38% (that is, a retention ratio of 62%), the fact that Cathay Financial Holding's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Cathay Financial Holding has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. 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 33%. Regardless, the future ROE for Cathay Financial Holding is predicted to rise to 9.5% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we have mixed feelings about Cathay Financial Holding. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.