# Will Weakness in China Mengniu Dairy Company Limited's (HKG:2319) Stock Prove Temporary Given Strong Fundamentals?

By
Simply Wall St
Published
May 13, 2022

It is hard to get excited after looking at China Mengniu Dairy's (HKG:2319) recent performance, when its stock has declined 19% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study China Mengniu Dairy's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for China Mengniu Dairy

### 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 China Mengniu Dairy is:

12% = CN¥5.0b ÷ CN¥42b (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. So, this means that for every HK\$1 of its shareholder's investments, the company generates a profit of HK\$0.12.

### 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. 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.

### China Mengniu Dairy's Earnings Growth And 12% ROE

At first glance, China Mengniu Dairy seems to have a decent ROE. On comparing with the average industry ROE of 9.6% the company's ROE looks pretty remarkable. This probably laid the ground for China Mengniu Dairy's significant 35% net income growth seen over the past five years. 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.

We then compared China Mengniu Dairy's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 7.4% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for 2319? You can find out in our latest intrinsic value infographic research report.

### Is China Mengniu Dairy Using Its Retained Earnings Effectively?

China Mengniu Dairy's three-year median payout ratio to shareholders is 21%, which is quite low. This implies that the company is retaining 79% of its profits. So it looks like China Mengniu Dairy is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, China Mengniu Dairy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 32% over the next three years. Still, forecasts suggest that China Mengniu Dairy's future ROE will rise to 16% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

### Summary

On the whole, we feel that China Mengniu Dairy's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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