China High Speed Transmission Equipment Group Co., Ltd.'s (HKG:658) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

China High Speed Transmission Equipment Group (HKG:658) has had a great run on the share market with its stock up by a significant 48% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to China High Speed Transmission Equipment Group's ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for China High Speed Transmission Equipment Group

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 China High Speed Transmission Equipment Group is:

4.0% = CN¥455m ÷ CN¥11b (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$0.04.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 China High Speed Transmission Equipment Group's Earnings Growth And 4.0% ROE

When you first look at it, China High Speed Transmission Equipment Group's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 5.9%, the company's ROE leaves us feeling even less enthusiastic. For this reason, China High Speed Transmission Equipment Group's five year net income decline of 20% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared China High Speed Transmission Equipment Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.0% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 China High Speed Transmission Equipment Group is trading on a high P/E or a low P/E, relative to its industry.

Is China High Speed Transmission Equipment Group Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 41% (where it is retaining 59% of its profits), China High Speed Transmission Equipment Group has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, China High Speed Transmission Equipment Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 104% over the next three years. Still, forecasts suggest that China High Speed Transmission Equipment Group's future ROE will rise to 6.8% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

On the whole, we feel that the performance shown by China High Speed Transmission Equipment Group can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.

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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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