Build King Holdings (HKG:240) has had a great run on the share market with its stock up by a significant 20% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Build King Holdings' ROE today.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Build King Holdings is:
28% = HK$440m ÷ HK$1.6b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.28.
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. 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. 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.
Build King Holdings' Earnings Growth And 28% ROE
To begin with, Build King Holdings has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 8.5% also doesn't go unnoticed by us. As a result, Build King Holdings' exceptional 25% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing with the industry net income growth, we found that Build King Holdings' growth is quite high when compared to the industry average growth of 1.0% 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. 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 Build King Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Build King Holdings Using Its Retained Earnings Effectively?
Build King Holdings' ' three-year median payout ratio is on the lower side at 16% implying that it is retaining a higher percentage (84%) of its profits. So it looks like Build King Holdings is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Besides, Build King Holdings has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders.
On the whole, we feel that Build King Holdings' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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 1 risk we have identified for Build King Holdings by visiting our risks dashboard for free on our platform here.
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