Kingsoft Corporation Limited's (HKG:3888) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

It is hard to get excited after looking at Kingsoft's (HKG:3888) recent performance, when its stock has declined 31% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Kingsoft's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Kingsoft

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Kingsoft is:

2.9% = CN¥839m ÷ CN¥29b (Based on the trailing twelve months to June 2022).

The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.03.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Kingsoft's Earnings Growth And 2.9% ROE

As you can see, Kingsoft's ROE looks pretty weak. Not just that, even compared to the industry average of 8.3%, the company's ROE is entirely unremarkable. However, the moderate 6.7% net income growth seen by Kingsoft over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Kingsoft's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 30% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Kingsoft fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kingsoft Using Its Retained Earnings Effectively?

In Kingsoft's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 22% (or a retention ratio of 78%), which suggests that the company is investing most of its profits to grow its business.

Additionally, Kingsoft has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 22%. However, Kingsoft's ROE is predicted to rise to 4.5% despite there being no anticipated change in its payout ratio.

Summary

Overall, we feel that Kingsoft certainly does have some positive factors to consider. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.