Hengan International Group Company Limited's (HKG:1044) Stock Is Going Strong: Have Financials A Role To Play?

Hengan International Group (HKG:1044) has had a great run on the share market with its stock up by a significant 7.0% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Hengan International Group's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Hengan International Group

How Is ROE Calculated?

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 Hengan International Group is:

14% = CN¥3.0b ÷ CN¥21b (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$0.14.

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.

Hengan International Group's Earnings Growth And 14% ROE

To begin with, Hengan International Group seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. However, while Hengan International Group has a pretty respectable ROE, its five year net income decline rate was 13% . We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

So, as a next step, we compared Hengan International Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 1.5% over the last few years.

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 1044? You can find out in our latest intrinsic value infographic research report.

Is Hengan International Group Making Efficient Use Of Its Profits?

Hengan International Group's 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 63% (or a retention ratio of 37%). 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.

Additionally, Hengan International Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. 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 58%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 12%.

Conclusion

On the whole, we do feel that Hengan International Group has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.