Is The Market Rewarding China Gingko Education Group Company Limited (HKG:1851) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

With its stock down 14% over the past three months, it is easy to disregard China Gingko Education Group (HKG:1851). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on China Gingko 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 Gingko Education Group

How To 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 China Gingko Education Group is:

5.8% = CN¥30m ÷ CN¥517m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.06 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Gingko Education Group's Earnings Growth And 5.8% ROE

On the face of it, China Gingko Education Group's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 12% either. For this reason, China Gingko Education Group's five year net income decline of 7.8% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared China Gingko Education Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 19% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about China Gingko Education Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Gingko Education Group Making Efficient Use Of Its Profits?

Conclusion

In total, we're a bit ambivalent about China Gingko Education Group's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 4 risks we have identified for China Gingko Education Group visit our risks dashboard for free.

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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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