Is The Market Rewarding China Aluminum Cans Holdings Limited (HKG:6898) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

It is hard to get excited after looking at China Aluminum Cans Holdings' (HKG:6898) recent performance, when its stock has declined 20% over the past month. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study China Aluminum Cans Holdings' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for China Aluminum Cans Holdings

How Do You 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 China Aluminum Cans Holdings is:

5.4% = HK$17m ÷ HK$322m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

China Aluminum Cans Holdings' Earnings Growth And 5.4% ROE

At first glance, China Aluminum Cans Holdings' ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.6%, so we won't completely dismiss the company. Having said that, China Aluminum Cans Holdings' five year net income decline rate was 28%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

However, when we compared China Aluminum Cans Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.7% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 China Aluminum Cans Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is China Aluminum Cans Holdings Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 31% (or a retention ratio of 69%) which is pretty normal, China Aluminum Cans Holdings' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, China Aluminum Cans Holdings has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

In total, we're a bit ambivalent about China Aluminum Cans Holdings' performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for China Aluminum Cans Holdings visit our risks dashboard for free.

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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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