Is Fairwood Holdings Limited's (HKG:52) Recent Performancer Underpinned By Weak Financials?

Fairwood Holdings (HKG:52) has had a rough week with its share price down 1.8%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on Fairwood Holdings' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Fairwood Holdings

How To Calculate Return On Equity?

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 Fairwood Holdings is:

9.5% = HK$69m ÷ HK$724m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.09 in profit.

Why Is ROE Important For 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.

Fairwood Holdings' Earnings Growth And 9.5% ROE

On the face of it, Fairwood Holdings' ROE is not much to talk about. However, the fact that the company's ROE is higher than the average industry ROE of 4.4%, is definitely interesting. However, Fairwood Holdings' five year net income decline rate was 15%. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to shrink.

So, as a next step, we compared Fairwood Holdings' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 1.3% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Fairwood Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Fairwood Holdings Using Its Retained Earnings Effectively?

Fairwood Holdings has a high three-year median payout ratio of 90% (that is, it is retaining 9.7% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 3 risks we have identified for Fairwood Holdings.

Additionally, Fairwood Holdings has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. 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 80%. However, Fairwood Holdings' ROE is predicted to rise to 21% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, Fairwood Holdings' performance is quite a big let-down. The company has shown a disappointing growth in its earnings as a result of it retaining little to almost none of its profits. So, the decent ROE it does have, is not much useful to investors given that the company is reinvesting very little 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. 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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