China Education Group Holdings Limited's (HKG:839) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

China Education Group Holdings (HKG:839) has had a great run on the share market with its stock up by a significant 11% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study China Education Group Holdings' ROE in this article.

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

Check out our latest analysis for China Education Group 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 Education Group Holdings is:

9.7% = CN¥1.8b ÷ CN¥18b (Based on the trailing twelve months to February 2023).

The 'return' is the yearly profit. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

China Education Group Holdings' Earnings Growth And 9.7% ROE

When you first look at it, China Education Group Holdings' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 12%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that China Education Group Holdings' net income grew significantly at a rate of 28% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared China Education Group Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 2.6%.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about China Education Group Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Education Group Holdings Using Its Retained Earnings Effectively?

China Education Group Holdings has a significant three-year median payout ratio of 55%, meaning the company only retains 45% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Additionally, China Education Group Holdings has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. 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 48%. However, China Education Group Holdings' ROE is predicted to rise to 13% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we feel that China Education Group Holdings certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. 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.