Can Mixed Fundamentals Have A Negative Impact on MECOM Power and Construction Limited (HKG:1183) Current Share Price Momentum?

Most readers would already be aware that MECOM Power and Construction's (HKG:1183) stock increased significantly by 96% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study MECOM Power and Construction's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for MECOM Power and Construction

How To Calculate Return On Equity?

Return on equity 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 MECOM Power and Construction is:

15% = MO$65m ÷ MO$418m (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.15.

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. 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 MECOM Power and Construction's Earnings Growth And 15% ROE

At first glance, MECOM Power and Construction seems to have a decent ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. As you might expect, the 14% net income decline reported by MECOM Power and Construction is a bit of a surprise. 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.

So, as a next step, we compared MECOM Power and Construction's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 0.09% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about MECOM Power and Construction's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is MECOM Power and Construction Using Its Retained Earnings Effectively?

MECOM Power and Construction's high three-year median payout ratio of 102% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. Our risks dashboard should have the 4 risks we have identified for MECOM Power and Construction.

In addition, MECOM Power and Construction has been paying dividends over a period of three years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Conclusion

On the whole, we feel that the performance shown by MECOM Power and Construction can be open to many interpretations. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into MECOM Power and Construction's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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This article by Simply Wall St is general in nature. 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.
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