Chen Lin Education Group Holdings Limited's (HKG:1593) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Chen Lin Education Group Holdings (HKG:1593) has had a great run on the share market with its stock up by a significant 37% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Chen Lin Education Group Holdings' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Chen Lin Education Group Holdings

How Do You 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 Chen Lin Education Group Holdings is:

7.8% = CN¥66m ÷ CN¥841m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.08 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Chen Lin Education Group Holdings' Earnings Growth And 7.8% ROE

At first glance, Chen Lin Education Group Holdings' ROE doesn't look very promising. Next, when compared to the average industry ROE of 11%, the company's ROE leaves us feeling even less enthusiastic. Although, we can see that Chen Lin Education Group Holdings saw a modest net income growth of 10% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Chen Lin Education Group Holdings' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Chen Lin Education Group Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chen Lin Education Group Holdings Making Efficient Use Of Its Profits?

In Chen Lin Education Group Holdings' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 20% (or a retention ratio of 80%), which suggests that the company is investing most of its profits to grow its business.

Along with seeing a growth in earnings, Chen Lin Education Group Holdings only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Conclusion

Overall, we feel that Chen Lin Education Group Holdings certainly does have some positive factors to consider. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for Chen Lin Education Group Holdings by visiting our risks dashboard for free on our platform here.

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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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