Does The Market Have A Low Tolerance For Most Kwai Chung Limited's (HKG:1716) Mixed Fundamentals?

Most Kwai Chung (HKG:1716) has had a rough week with its share price down 5.0%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Most Kwai Chung's 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Most Kwai Chung

How To 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 Most Kwai Chung is:

14% = HK$15m ÷ HK$109m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.14 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. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Most Kwai Chung's Earnings Growth And 14% ROE

To start with, Most Kwai Chung's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. For this reason, Most Kwai Chung's five year net income decline of 16% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Most Kwai Chung's performance with the industry and found thatMost Kwai Chung's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 4.6% in the same period, which is a slower than the company.

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). 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 1716? You can find out in our latest intrinsic value infographic research report

Is Most Kwai Chung Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 91% (implying that 9.5% of the profits are retained), most of Most Kwai Chung's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 3 risks we have identified for Most Kwai Chung visit our risks dashboard for free.

Additionally, Most Kwai Chung started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Summary

On the whole, we feel that the performance shown by Most Kwai Chung can be open to many interpretations. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Most Kwai Chung's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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