Is Weakness In Nongfu Spring Co., Ltd. (HKG:9633) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 35% over the past three months, it is easy to disregard Nongfu Spring (HKG:9633). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Nongfu Spring'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Nongfu Spring

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 Nongfu Spring is:

48% = CN¥13b ÷ CN¥26b (Based on the trailing twelve months to June 2024).

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$0.48.

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. 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.

A Side By Side comparison of Nongfu Spring's Earnings Growth And 48% 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 11% which is quite remarkable. As a result, Nongfu Spring's exceptional 23% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing Nongfu Spring's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 20% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 9633? You can find out in our latest intrinsic value infographic research report.

Is Nongfu Spring Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 69% (implying that it keeps only 31% of profits) for Nongfu Spring suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Besides, Nongfu Spring has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. 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 75%. As a result, Nongfu Spring's ROE is not expected to change by much either, which we inferred from the analyst estimate of 41% for future ROE.

Conclusion

Overall, we are quite pleased with Nongfu Spring's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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 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.