Is Weakness In Loco Hong Kong Holdings Limited (HKG:8162) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Loco Hong Kong Holdings (HKG:8162) has had a rough week with its share price down 25%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Loco Hong Kong 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Loco Hong Kong Holdings

How Do You 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 Loco Hong Kong Holdings is:

43% = HK$17m ÷ HK$40m (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.43 in profit.

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 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.

Loco Hong Kong Holdings' Earnings Growth And 43% ROE

First thing first, we like that Loco Hong Kong Holdings has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 4.6% which is quite remarkable. As a result, Loco Hong Kong Holdings' exceptional 20% 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 Loco Hong Kong Holdings' growth is quite high when compared to the industry average growth of 5.5% in the same period, which is great to see.

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 Loco Hong Kong Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is Loco Hong Kong Holdings Using Its Retained Earnings Effectively?

Loco Hong Kong Holdings doesn't pay any regular dividends to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Conclusion

Overall, we are quite pleased with Loco Hong Kong Holdings' performance. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 3 risks we have identified for Loco Hong Kong Holdings.

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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.