It is hard to get excited after looking at Nexteer Automotive Group's (HKG:1316) recent performance, when its stock has declined 18% over the past three months. 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. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Nexteer Automotive Group'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
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 Nexteer Automotive Group is:
6.4% = US$122m ÷ US$1.9b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.06 in profit.
What Has ROE Got To Do With 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.
A Side By Side comparison of Nexteer Automotive Group's Earnings Growth And 6.4% ROE
On the face of it, Nexteer Automotive Group's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.5% either. For this reason, Nexteer Automotive Group's five year net income decline of 8.6% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. 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 Nexteer Automotive Group's performance with the industry and found thatNexteer Automotive Group's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.02% in the same period, which is a slower than the company.
Earnings growth is a huge factor in stock valuation. 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 1316 worth today? The intrinsic value infographic in our free research report helps visualize whether 1316 is currently mispriced by the market.
Is Nexteer Automotive Group Using Its Retained Earnings Effectively?
Nexteer Automotive Group's low three-year median payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. 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, Nexteer Automotive Group has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 22% of its profits over the next three years. Regardless, the future ROE for Nexteer Automotive Group is predicted to rise to 13% despite there being not much change expected in its payout ratio.
In total, we're a bit ambivalent about Nexteer Automotive Group'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. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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