China Mengniu Dairy Company Limited's (HKG:2319) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 18% over the past month, it is easy to disregard China Mengniu Dairy (HKG:2319). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study China Mengniu Dairy's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for China Mengniu Dairy

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for China Mengniu Dairy is:

9.6% = CN¥4.9b ÷ CN¥51b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.10.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

China Mengniu Dairy's Earnings Growth And 9.6% ROE

On the face of it, China Mengniu Dairy's ROE is not much to talk about. However, its ROE is similar to the industry average of 8.7%, so we won't completely dismiss the company. Having said that, China Mengniu Dairy has shown a modest net income growth of 9.8% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared China Mengniu Dairy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 0.7%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about China Mengniu Dairy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Mengniu Dairy Making Efficient Use Of Its Profits?

China Mengniu Dairy has a healthy combination of a moderate three-year median payout ratio of 29% (or a retention ratio of 71%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, China Mengniu Dairy has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 43% over the next three years. Still, forecasts suggest that China Mengniu Dairy's future ROE will rise to 12% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we feel that China Mengniu Dairy certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.