Café de Coral Holdings Limited (HKG:341) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Café de Coral Holdings (HKG:341) has had a great run on the share market with its stock up by a significant 13% over the last week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Café de Coral Holdings' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Café de Coral Holdings

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 Café de Coral Holdings is:

11% = HK$333m ÷ HK$2.9b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.11.

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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Café de Coral Holdings' Earnings Growth And 11% ROE

At first glance, Café de Coral Holdings seems to have a decent ROE. On comparing with the average industry ROE of 6.8% the company's ROE looks pretty remarkable. For this reason, Café de Coral Holdings' five year net income decline of 22% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

However, when we compared Café de Coral Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Café de Coral Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Café de Coral Holdings Making Efficient Use Of Its Profits?

Café de Coral Holdings' very high three-year median payout ratio of 128% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term.

Moreover, Café de Coral Holdings has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 102% over the next three years. As a result, the expected drop in Café de Coral Holdings' payout ratio explains the anticipated rise in the company's future ROE to 17%, over the same period.

Summary

In total, we're a bit ambivalent about Café de Coral Holdings' performance. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.