BYD Company Limited's (HKG:1211) Stock Is Going Strong: Is the Market Following Fundamentals?

BYD's (HKG:1211) stock is up by a considerable 17% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on BYD's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for BYD

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 BYD is:

21% = CN¥35b ÷ CN¥169b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.21 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of BYD's Earnings Growth And 21% ROE

To start with, BYD's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 16%. This probably laid the ground for BYD's significant 57% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared BYD's 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 15% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for 1211? You can find out in our latest intrinsic value infographic research report.

Is BYD Using Its Retained Earnings Effectively?

BYD's ' three-year median payout ratio is on the lower side at 14% implying that it is retaining a higher percentage (86%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, BYD is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 30% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

Overall, we are quite pleased with BYD's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.