Should Weakness in WEILONG Delicious Global Holdings Ltd's (HKG:9985) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

WEILONG Delicious Global Holdings (HKG:9985) has had a rough three months with its share price down 27%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study WEILONG Delicious Global Holdings' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for WEILONG Delicious Global Holdings

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 WEILONG Delicious Global Holdings is:

16% = CN¥859m ÷ CN¥5.5b (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.16 in profit.

Why Is ROE Important For 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 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 WEILONG Delicious Global Holdings' Earnings Growth And 16% ROE

To begin with, WEILONG Delicious Global Holdings seems to have a respectable ROE. Especially when compared to the industry average of 9.2% the company's ROE looks pretty impressive. Needless to say, we are quite surprised to see that WEILONG Delicious Global Holdings' net income shrunk at a rate of 17% over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

However, when we compared WEILONG Delicious Global Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.2% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 WEILONG Delicious Global Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is WEILONG Delicious Global Holdings Efficiently Re-investing Its Profits?

WEILONG Delicious Global Holdings' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 79% (or a retention ratio of 21%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run.

Only recently, WEILONG Delicious Global Holdings stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 51% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

Overall, we feel that WEILONG Delicious Global Holdings certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.