Will Weakness in Tsingtao Brewery Company Limited's (HKG:168) Stock Prove Temporary Given Strong Fundamentals?

Tsingtao Brewery (HKG:168) has had a rough three months with its share price down 18%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Tsingtao Brewery's ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Tsingtao Brewery

How Do You 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 Tsingtao Brewery is:

15% = CN¥4.4b ÷ CN¥29b (Based on the trailing twelve months to September 2023).

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$0.15 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Tsingtao Brewery's Earnings Growth And 15% ROE

To begin with, Tsingtao Brewery seems to have a respectable ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. This probably goes some way in explaining Tsingtao Brewery's significant 23% net income growth over the past five years amongst other factors. We believe that there might also be 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.

Next, on comparing Tsingtao Brewery's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 23% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Tsingtao Brewery is trading on a high P/E or a low P/E, relative to its industry.

Is Tsingtao Brewery Making Efficient Use Of Its Profits?

The three-year median payout ratio for Tsingtao Brewery is 41%, which is moderately low. The company is retaining the remaining 59%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Tsingtao Brewery is reinvesting its earnings efficiently.

Additionally, Tsingtao Brewery has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 62% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

Overall, we are quite pleased with Tsingtao Brewery's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.