Weak Financial Prospects Seem To Be Dragging Down FriendTimes Inc. (HKG:6820) Stock

With its stock down 30% over the past three months, it is easy to disregard FriendTimes (HKG:6820). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on FriendTimes' ROE.

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 FriendTimes

How To 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 FriendTimes is:

1.3% = CN¥17m ÷ CN¥1.3b (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.01 in profit.

What Has ROE Got To Do With 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. 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.

FriendTimes' Earnings Growth And 1.3% ROE

As you can see, FriendTimes' ROE looks pretty weak. Even when compared to the industry average of 6.5%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 36% seen by FriendTimes was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared FriendTimes' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.7% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 FriendTimes is trading on a high P/E or a low P/E, relative to its industry.

Is FriendTimes Using Its Retained Earnings Effectively?

FriendTimes has a high three-year median payout ratio of 53% (that is, it is retaining 47% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for FriendTimes.

In addition, FriendTimes has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. 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 51%. However, FriendTimes' ROE is predicted to rise to 16% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, FriendTimes' performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low 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. 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.