Does The Market Have A Low Tolerance For Top Education Group Ltd's (HKG:1752) Mixed Fundamentals?

It is hard to get excited after looking at Top Education Group's (HKG:1752) recent performance, when its stock has declined 15% over the past month. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Top Education Group's 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Top Education Group

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Top Education Group is:

8.7% = AU$4.5m ÷ AU$51m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.09.

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. 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.

A Side By Side comparison of Top Education Group's Earnings Growth And 8.7% ROE

At first glance, Top Education Group's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 11%. Hence, the flat earnings seen by Top Education Group over the past five years could probably be the result of it having a lower ROE.

We then compared Top Education Group's net income growth with the industry and found that the average industry growth rate was 19% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Top Education Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Top Education Group Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 43% (meaning the company retains57% of profits) in the last three-year period, Top Education Group's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Top Education Group only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Conclusion

In total, we're a bit ambivalent about Top Education Group's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Top Education Group's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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