China East Education Holdings Limited's (HKG:667) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

China East Education Holdings (HKG:667) has had a great run on the share market with its stock up by a significant 13% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to China East Education 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for China East Education 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 China East Education Holdings is:

6.2% = CN¥340m ÷ CN¥5.5b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.06.

What Has ROE Got To Do With 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. 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.

China East Education Holdings' Earnings Growth And 6.2% ROE

On the face of it, China East Education Holdings' ROE is not much to talk about. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 21% seen by China East Education Holdings was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

However, when we compared China East Education Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.1% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is China East Education Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is China East Education Holdings Using Its Retained Earnings Effectively?

China East Education 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 higher than reported profits is not a sustainable move.

Additionally, China East Education Holdings has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 81% over the next three years. As a result, the expected drop in China East Education Holdings' payout ratio explains the anticipated rise in the company's future ROE to 9.5%, over the same period.

Summary

On the whole, China East Education Holdings' performance is quite a big let-down. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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.