Is Huangshan Tourism Development Co.,Ltd.'s (SHSE:600054) Recent Price Movement Underpinned By Its Weak Fundamentals?

Huangshan Tourism DevelopmentLtd (SHSE:600054) has had a rough week with its share price down 12%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Huangshan Tourism DevelopmentLtd's ROE today.

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 Huangshan Tourism DevelopmentLtd

How To Calculate Return On Equity?

ROE 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 Huangshan Tourism DevelopmentLtd is:

8.2% = CN¥384m ÷ CN¥4.7b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.08 in profit.

Why Is ROE Important For 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.

Huangshan Tourism DevelopmentLtd's Earnings Growth And 8.2% ROE

When you first look at it, Huangshan Tourism DevelopmentLtd's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.2%. Having said that, Huangshan Tourism DevelopmentLtd's five year net income decline rate was 3.2%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

That being said, we compared Huangshan Tourism DevelopmentLtd'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 1.1% in the same 5-year 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is 600054 worth today? The intrinsic value infographic in our free research report helps visualize whether 600054 is currently mispriced by the market.

Is Huangshan Tourism DevelopmentLtd Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 36% (or a retention ratio of 64%) which is pretty normal, Huangshan Tourism DevelopmentLtd'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. 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, Huangshan Tourism DevelopmentLtd 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 38%. As a result, Huangshan Tourism DevelopmentLtd's ROE is not expected to change by much either, which we inferred from the analyst estimate of 9.1% for future ROE.

Summary

Overall, we have mixed feelings about Huangshan Tourism DevelopmentLtd. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.