Is Weakness In CM Hi-Tech Cleanroom Limited (HKG:2115) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 23% over the past three months, it is easy to disregard CM Hi-Tech Cleanroom (HKG:2115). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on CM Hi-Tech Cleanroom's ROE.

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

Check out our latest analysis for CM Hi-Tech Cleanroom

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for CM Hi-Tech Cleanroom is:

22% = CN¥67m ÷ CN¥308m (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.22 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 CM Hi-Tech Cleanroom's Earnings Growth And 22% ROE

To start with, CM Hi-Tech Cleanroom's ROE looks acceptable. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This probably laid the ground for CM Hi-Tech Cleanroom's significant 40% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that CM Hi-Tech Cleanroom's growth is quite high when compared to the industry average growth of 9.1% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about CM Hi-Tech Cleanroom's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is CM Hi-Tech Cleanroom Efficiently Re-investing Its Profits?

The three-year median payout ratio for CM Hi-Tech Cleanroom is 28%, which is moderately low. The company is retaining the remaining 72%. So it seems that CM Hi-Tech Cleanroom is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Along with seeing a growth in earnings, CM Hi-Tech Cleanroom only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 30%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 26%.

Conclusion

Overall, we are quite pleased with CM Hi-Tech Cleanroom'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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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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.