Zhou Hei Ya International Holdings Company Limited's (HKG:1458) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Zhou Hei Ya International Holdings' (HKG:1458) stock is up by a considerable 26% over the past month. 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. Specifically, we decided to study Zhou Hei Ya International 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Zhou Hei Ya International Holdings

How To Calculate Return On Equity?

Return on equity 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 Zhou Hei Ya International Holdings is:

3.5% = CN¥141m ÷ CN¥4.0b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.04.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Zhou Hei Ya International Holdings' Earnings Growth And 3.5% ROE

When you first look at it, Zhou Hei Ya International Holdings' ROE doesn't look that attractive. 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 11%. Therefore, it might not be wrong to say that the five year net income decline of 16% seen by Zhou Hei Ya International 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 Zhou Hei Ya International Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.

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. What is 1458 worth today? The intrinsic value infographic in our free research report helps visualize whether 1458 is currently mispriced by the market.

Is Zhou Hei Ya International Holdings Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 57% (implying that 43% of the profits are retained), most of Zhou Hei Ya International Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Zhou Hei Ya International Holdings.

Moreover, Zhou Hei Ya International Holdings has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. 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 56%. Still, forecasts suggest that Zhou Hei Ya International Holdings' future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we would have a hard think before deciding on any investment action concerning Zhou Hei Ya International 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. 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. 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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