Will Weakness in China New Higher Education Group Limited's (HKG:2001) Stock Prove Temporary Given Strong Fundamentals?

China New Higher Education Group (HKG:2001) has had a rough three months with its share price down 11%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to China New Higher Education Group's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for China New Higher Education Group

How Is ROE Calculated?

ROE 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 China New Higher Education Group is:

12% = CN¥296m ÷ CN¥2.5b (Based on the trailing twelve months to August 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 China New Higher Education Group's Earnings Growth And 12% ROE

At first glance, China New Higher Education Group seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 11%. This certainly adds some context to China New Higher Education Group's exceptional 26% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared China New Higher Education Group's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 19% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about China New Higher Education Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China New Higher Education Group Efficiently Re-investing Its Profits?

The three-year median payout ratio for China New Higher Education Group is 27%, which is moderately low. The company is retaining the remaining 73%. So it seems that China New Higher Education Group is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, China New Higher Education Group has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 27%. Still, forecasts suggest that China New Higher Education Group's future ROE will rise to 19% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we are quite pleased with China New Higher Education Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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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