Has Churchill China plc's (LON:CHH) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Most readers would already be aware that Churchill China's (LON:CHH) stock increased significantly by 13% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Churchill China's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Churchill China

How Do You 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 Churchill China is:

14% = UK£8.2m ÷ UK£58m (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.14 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Churchill China's Earnings Growth And 14% ROE

To start with, Churchill China's ROE looks acceptable. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Needless to say, we are quite surprised to see that Churchill China's net income shrunk at a rate of 3.6% over the past five years. 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.

Next, on comparing with the industry net income growth, we found that Churchill China's earnings seems to be shrinking at a similar rate as the industry which shrunk at a rate of a rate of 3.6% 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. If you're wondering about Churchill China's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Churchill China Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 44% (that is, a retention ratio of 56%), the fact that Churchill China's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Churchill China 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 50% of its profits over the next three years. As a result, Churchill China's ROE is not expected to change by much either, which we inferred from the analyst estimate of 13% for future ROE.

Conclusion

Overall, we feel that Churchill China 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. 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 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.