Lever Style Corporation's (HKG:1346) Dismal Stock Performance Reflects Weak Fundamentals

It is hard to get excited after looking at Lever Style's (HKG:1346) recent performance, when its stock has declined 8.2% over the past month. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Lever Style's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Lever Style

How To 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 Lever Style is:

2.0% = US$571k ÷ US$29m (Based on the trailing twelve months to June 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$0.02.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Lever Style's Earnings Growth And 2.0% ROE

It is quite clear that Lever Style's ROE is rather low. Not just that, even compared to the industry average of 6.5%, the company's ROE is entirely unremarkable. For this reason, Lever Style's five year net income decline of 16% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 2.2% in the same period, we found that Lever Style's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Lever Style fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Lever Style Efficiently Re-investing Its Profits?

Lever Style's high three-year median payout ratio of 103% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. You can see the 4 risks we have identified for Lever Style by visiting our risks dashboard for free on our platform here.

Additionally, Lever Style started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 50% over the next three years. As a result, the expected drop in Lever Style's payout ratio explains the anticipated rise in the company's future ROE to 20%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on Lever Style. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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