Is China 21st Century Education Group Limited's(HKG:1598) Recent Stock Performance Tethered To Its Strong Fundamentals?

China 21st Century Education Group (HKG:1598) has had a great run on the share market with its stock up by a significant 25% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on China 21st Century Education Group's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for China 21st Century Education Group

How Is ROE Calculated?

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 21st Century Education Group is:

9.9% = CN¥69m ÷ CN¥696m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.10 in profit.

What Is The Relationship Between ROE And 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.

China 21st Century Education Group's Earnings Growth And 9.9% ROE

At first glance, China 21st Century Education Group seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. This certainly adds some context to China 21st Century Education Group's exceptional 22% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between China 21st Century Education Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 19% in the same period.

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. 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 21st Century Education Group is trading on a high P/E or a low P/E, relative to its industry.

Is China 21st Century Education Group Using Its Retained Earnings Effectively?

The three-year median payout ratio for China 21st Century Education Group is 32%, which is moderately low. The company is retaining the remaining 68%. By the looks of it, the dividend is well covered and China 21st Century Education Group is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Along with seeing a growth in earnings, China 21st Century Education Group only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Conclusion

Overall, we are quite pleased with China 21st Century Education Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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