Declining Stock and Decent Financials: Is The Market Wrong About Xiabuxiabu Catering Management (China) Holdings Co., Ltd. (HKG:520)?

Xiabuxiabu Catering Management (China) Holdings (HKG:520) has had a rough three months with its share price down 27%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Xiabuxiabu Catering Management (China) Holdings' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Xiabuxiabu Catering Management (China) Holdings

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Xiabuxiabu Catering Management (China) Holdings is:

9.5% = CN¥217m ÷ CN¥2.3b (Based on the trailing twelve months to June 2021).

The 'return' is the profit 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.

Xiabuxiabu Catering Management (China) Holdings' Earnings Growth And 9.5% ROE

To start with, Xiabuxiabu Catering Management (China) Holdings' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 5.3%. For this reason, Xiabuxiabu Catering Management (China) Holdings' five year net income decline of 25% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Xiabuxiabu Catering Management (China) Holdings' performance with the industry and found thatXiabuxiabu Catering Management (China) Holdings' performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 6.8% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. 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. Is Xiabuxiabu Catering Management (China) Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Xiabuxiabu Catering Management (China) Holdings Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 40% (where it is retaining 60% of its profits), Xiabuxiabu Catering Management (China) Holdings has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Xiabuxiabu Catering Management (China) Holdings has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 38%. Regardless, the future ROE for Xiabuxiabu Catering Management (China) Holdings is predicted to rise to 19% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we feel that Xiabuxiabu Catering Management (China) Holdings certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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.
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