Are Strong Financial Prospects The Force That Is Driving The Momentum In Tongcheng Travel Holdings Limited's HKG:780) Stock?

Tongcheng Travel Holdings' (HKG:780) stock is up by a considerable 32% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Tongcheng Travel Holdings' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 Tongcheng Travel Holdings

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Tongcheng Travel Holdings is:

9.5% = CN¥1.9b ÷ CN¥20b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned 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.

What Is The Relationship Between ROE And 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 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.

Tongcheng Travel Holdings' Earnings Growth And 9.5% ROE

When you first look at it, Tongcheng Travel Holdings' ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 7.0% which we definitely can't overlook. Particularly, the substantial 29% net income growth seen by Tongcheng Travel Holdings over the past five years is impressive . Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence, there might be some other aspects that are causing earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

Next, on comparing with the industry net income growth, we found that Tongcheng Travel Holdings' growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. What is 780 worth today? The intrinsic value infographic in our free research report helps visualize whether 780 is currently mispriced by the market.

Is Tongcheng Travel Holdings Efficiently Re-investing Its Profits?

Tongcheng Travel Holdings has a really low three-year median payout ratio of 20%, meaning that it has the remaining 80% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

While Tongcheng Travel Holdings has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 15% over the next three years. As a result, the expected drop in Tongcheng Travel Holdings' payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.

Summary

In total, we are pretty happy with Tongcheng Travel Holdings' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.