With its stock down 7.5% over the past month, it is easy to disregard China Tianbao Group Development (HKG:1427). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study China Tianbao Group Development'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 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?
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 China Tianbao Group Development is:
32% = CN¥389m ÷ CN¥1.2b (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.32 in profit.
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. 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.
A Side By Side comparison of China Tianbao Group Development's Earnings Growth And 32% ROE
First thing first, we like that China Tianbao Group Development has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 10% also doesn't go unnoticed by us. So, the substantial 51% net income growth seen by China Tianbao Group Development over the past five years isn't overly surprising.
Given that the industry shrunk its earnings at a rate of 0.1% in the same period, the net income growth of the company is quite impressive.
Earnings growth is an important metric to consider when valuing a stock. 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. 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 China Tianbao Group Development is trading on a high P/E or a low P/E, relative to its industry.
Is China Tianbao Group Development Making Efficient Use Of Its Profits?
China Tianbao Group Development's ' three-year median payout ratio is on the lower side at 2.1% implying that it is retaining a higher percentage (98%) of its profits. So it looks like China Tianbao Group Development is reinvesting profits heavily to grow its business, which shows in its earnings growth.
In total, we are pretty happy with China Tianbao Group Development'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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for China Tianbao Group Development by visiting our risks dashboard for free on our platform here.
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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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