Nongfu Spring's (HKG:9633) stock is up by a considerable 15% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Nongfu Spring'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Nongfu Spring is:
37% = CN¥6.4b ÷ CN¥18b (Based on the trailing twelve months to June 2021).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.37 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of Nongfu Spring's Earnings Growth And 37% ROE
Firstly, we acknowledge that Nongfu Spring has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. This probably laid the groundwork for Nongfu Spring's moderate 17% net income growth seen over the past five years.
As a next step, we compared Nongfu Spring's 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 5.5%.
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 Nongfu Spring fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Nongfu Spring Using Its Retained Earnings Effectively?
Nongfu Spring's high three-year median payout ratio of 108% suggests that the company is paying out more to its shareholders than what it is making. However, this hasn't really hampered its ability to grow as we saw earlier. It would still be worth keeping an eye on that high payout ratio, if for some reason the company runs into problems and business deteriorates.
While Nongfu Spring has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 40% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
On the whole, we do feel that Nongfu Spring has some positive attributes. Specifically, its high ROE which likely led to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the high rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.