Is BYD Company Limited's (HKG:1211) Stock Price Struggling As A Result Of Its Mixed Financials?

With its stock down 46% over the past three months, it is easy to disregard BYD (HKG:1211). 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. Specifically, we decided to study BYD's ROE in this article.

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.

View 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:

7.0% = CN¥6.2b ÷ CN¥89b (Based on the trailing twelve months to March 2021).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.07 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 7.0% ROE

At first glance, BYD's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.3% either. Therefore, it might not be wrong to say that the five year net income decline of 10% seen by BYD was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

As a next step, we compared BYD's performance with the industry and found thatBYD's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 4.0% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if BYD is trading on a high P/E or a low P/E, relative to its industry.

Is BYD Efficiently Re-investing Its Profits?

BYD's low three-year median payout ratio of 14% (or a retention ratio of 86%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, BYD has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 9.8% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 9.1%, over the same period.

Conclusion

In total, we're a bit ambivalent about BYD's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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