Are Robust Financials Driving The Recent Rally In China Feihe Limited's (HKG:6186) Stock?

China Feihe (HKG:6186) has had a great run on the share market with its stock up by a significant 17% over the last month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on China Feihe's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for China Feihe

How Is ROE Calculated?

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 Feihe is:

34% = CN¥4.9b ÷ CN¥14b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.34 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

China Feihe's Earnings Growth And 34% ROE

First thing first, we like that China Feihe has an impressive ROE. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. As a result, China Feihe's exceptional 45% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that China Feihe's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is 6186 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is China Feihe Making Efficient Use Of Its Profits?

The three-year median payout ratio for China Feihe is 45%, which is moderately low. The company is retaining the remaining 55%. So it seems that China Feihe is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Along with seeing a growth in earnings, China Feihe only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 38%. As a result, China Feihe's ROE is not expected to change by much either, which we inferred from the analyst estimate of 38% for future ROE.

Conclusion

In total, we are pretty happy with China Feihe'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. 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. 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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