Is First Tractor Company Limited's (HKG:38) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

First Tractor's (HKG:38) stock is up by a considerable 14% over the past 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. Specifically, we decided to study First Tractor'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.

View our latest analysis for First Tractor

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for First Tractor is:

14% = CN¥1.1b ÷ CN¥7.8b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax 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$0.14 in profit.

What Is The Relationship Between ROE And 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. 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 First Tractor's Earnings Growth And 14% ROE

To begin with, First Tractor seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. This certainly adds some context to First Tractor's exceptional 56% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared First Tractor's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.6% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about First Tractor's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is First Tractor Using Its Retained Earnings Effectively?

First Tractor has a three-year median payout ratio of 28% (where it is retaining 72% of its income) which is not too low or not too high. So it seems that First Tractor is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, First Tractor has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

In total, we are pretty happy with First Tractor's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.