Does China Wan Tong Yuan (Holdings) Limited's (HKG:6966) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that China Wan Tong Yuan (Holdings)'s (HKG:6966) stock increased significantly by 29% over the past month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study China Wan Tong Yuan (Holdings)'s ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for China Wan Tong Yuan (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 China Wan Tong Yuan (Holdings) is:

7.7% = CN¥18m ÷ CN¥228m (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.08 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 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 Wan Tong Yuan (Holdings)'s Earnings Growth And 7.7% ROE

At first glance, China Wan Tong Yuan (Holdings)'s ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 15%. For this reason, China Wan Tong Yuan (Holdings)'s five year net income decline of 4.0% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared China Wan Tong Yuan (Holdings)'s growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.0% 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. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if China Wan Tong Yuan (Holdings) is trading on a high P/E or a low P/E, relative to its industry.

Is China Wan Tong Yuan (Holdings) Making Efficient Use Of Its Profits?

China Wan Tong Yuan (Holdings) has a high three-year median payout ratio of 51% (that is, it is retaining 49% 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 4 risks we have identified for China Wan Tong Yuan (Holdings).

Summary

In total, we would have a hard think before deciding on any investment action concerning China Wan Tong Yuan (Holdings). Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of China Wan Tong Yuan (Holdings)'s past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.