Declining Stock and Solid Fundamentals: Is The Market Wrong About Royale Home Holdings Limited (HKG:1198)?

With its stock down 9.6% over the past three months, it is easy to disregard Royale Home Holdings (HKG:1198). 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. Specifically, we decided to study Royale Home Holdings' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Royale Home 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 Royale Home Holdings is:

29% = HK$751m ÷ HK$2.6b (Based on the trailing twelve months to June 2021).

The 'return' is the income the business earned over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.29 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. 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.

Royale Home Holdings' Earnings Growth And 29% ROE

To begin with, Royale Home Holdings has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 14% also doesn't go unnoticed by us. Under the circumstances, Royale Home Holdings' considerable five year net income growth of 68% was to be expected.

As a next step, we compared Royale Home Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.4%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Royale Home Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is Royale Home Holdings Using Its Retained Earnings Effectively?

Royale Home Holdings' three-year median payout ratio to shareholders is 14%, which is quite low. This implies that the company is retaining 86% of its profits. So it looks like Royale Home Holdings is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Royale Home Holdings 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.

Conclusion

On the whole, we feel that Royale Home 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 Royale Home Holdings by visiting our risks dashboard for free on our platform here.

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.

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