Declining Stock and Decent Financials: Is The Market Wrong About Hebei Yichen Industrial Group Corporation Limited (HKG:1596)?

With its stock down 1.3% over the past month, it is easy to disregard Hebei Yichen Industrial Group (HKG:1596). 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. Particularly, we will be paying attention to Hebei Yichen Industrial Group's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Hebei Yichen Industrial Group

How Is ROE Calculated?

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 Hebei Yichen Industrial Group is:

9.9% = CN¥197m ÷ CN¥2.0b (Based on the trailing twelve months to December 2019).

The 'return' is the yearly profit. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.10 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Hebei Yichen Industrial Group's Earnings Growth And 9.9% ROE

At first glance, Hebei Yichen Industrial Group seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 9.0%. As you might expect, the 11% net income decline reported by Hebei Yichen Industrial Group is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

That being said, we compared Hebei Yichen Industrial Group's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 14% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Hebei Yichen Industrial Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hebei Yichen Industrial Group Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 42% (that is, a retention ratio of 58%), the fact that Hebei Yichen Industrial Group's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Hebei Yichen Industrial Group has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we do feel that Hebei Yichen Industrial Group has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. 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 will have the 1 risk we have identified for Hebei Yichen Industrial 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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