CA Cultural Technology Group Limited's (HKG:1566) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

CA Cultural Technology Group (HKG:1566) has had a rough three months with its share price down 23%. 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 CA Cultural Technology Group's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for CA Cultural Technology Group

How Do You Calculate Return On Equity?

Return on equity 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 CA Cultural Technology Group is:

14% = HK$134m ÷ HK$967m (Based on the trailing twelve months to March 2020).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.14 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

CA Cultural Technology Group's Earnings Growth And 14% ROE

To begin with, CA Cultural Technology Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 5.7%. For this reason, CA Cultural Technology Group's five year net income decline of 9.4% raises the question as to why the high ROE didn't translate into earnings growth. 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. 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 CA Cultural Technology Group'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 6.8% in the same period.

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). Doing so will help them establish if the stock's future looks promising or ominous. 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 CA Cultural Technology Group is trading on a high P/E or a low P/E, relative to its industry.

Is CA Cultural Technology Group Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 40% (or a retention ratio of 60%) which is pretty normal, CA Cultural Technology Group's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Conclusion

Overall, we feel that CA Cultural Technology Group certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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. Our risks dashboard would have the 6 risks we have identified for CA Cultural Technology Group.

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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. 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.
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