Will Weakness in China Xinhua Education Group Limited's (HKG:2779) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 4.0% over the past week, it is easy to disregard China Xinhua Education Group (HKG:2779). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on China Xinhua 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for China Xinhua Education Group

How Do You 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 Xinhua Education Group is:

9.9% = CN¥271m ÷ CN¥2.7b (Based on the trailing twelve months to June 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$0.10 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

China Xinhua Education Group's Earnings Growth And 9.9% ROE

At first glance, China Xinhua Education Group seems to have a decent ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. This probably goes some way in explaining China Xinhua Education Group's moderate 16% growth over the past five years amongst other factors.

Next, on comparing China Xinhua Education Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 18% 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about China Xinhua Education Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

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

China Xinhua Education Group has a healthy combination of a moderate three-year median payout ratio of 29% (or a retention ratio of 71%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

While China Xinhua Education Group has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 36% over the next three years. Still, forecasts suggest that China Xinhua Education Group's future ROE will rise to 12% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

In total, we are pretty happy with China Xinhua 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. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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