China Gas Holdings Limited's (HKG:384) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at China Gas Holdings' (HKG:384) recent performance, when its stock has declined 6.5% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study China Gas Holdings' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for China Gas Holdings

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 China Gas Holdings is:

22% = HK$10b ÷ HK$46b (Based on the trailing twelve months to March 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.22 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. 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 Gas Holdings' Earnings Growth And 22% ROE

Firstly, we acknowledge that China Gas Holdings has a significantly high ROE. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. Under the circumstances, China Gas Holdings' considerable five year net income growth of 28% was to be expected.

We then compared China Gas Holdings' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% 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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 384? You can find out in our latest intrinsic value infographic research report.

Is China Gas Holdings Using Its Retained Earnings Effectively?

China Gas Holdings' three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like China Gas Holdings is reinvesting its earnings efficiently.

Additionally, China Gas Holdings has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 28% of its profits over the next three years. Accordingly, forecasts suggest that China Gas Holdings' future ROE will be 22% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with China Gas Holdings' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. 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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