Has China Rare Earth Holdings Limited's (HKG:769) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

China Rare Earth Holdings (HKG:769) has had a great run on the share market with its stock up by a significant 113% over the last 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 China Rare Earth Holdings' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for China Rare Earth 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 China Rare Earth Holdings is:

1.4% = HK$36m ÷ HK$2.6b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Rare Earth Holdings' Earnings Growth And 1.4% ROE

As you can see, China Rare Earth Holdings' ROE looks pretty weak. Not just that, even compared to the industry average of 6.3%, the company's ROE is entirely unremarkable. Despite this, surprisingly, China Rare Earth Holdings saw an exceptional 62% net income growth over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared China Rare Earth Holdings' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 24% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 China Rare Earth Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is China Rare Earth Holdings Efficiently Re-investing Its Profits?

China Rare Earth Holdings doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

In total, it does look like China Rare Earth Holdings has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for China Rare Earth Holdings.

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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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