Will Weakness in FriendTimes Inc.'s (HKG:6820) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 48% over the past three months, it is easy to disregard FriendTimes (HKG:6820). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for FriendTimes

How Is ROE Calculated?

Return on equity 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 FriendTimes is:

34% = CN¥429m ÷ CN¥1.3b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.34 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. 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. 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.

FriendTimes' Earnings Growth And 34% ROE

Firstly, we acknowledge that FriendTimes has a significantly high ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Under the circumstances, FriendTimes' considerable five year net income growth of 35% was to be expected.

Next, on comparing FriendTimes' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 32% 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. If you're wondering about FriendTimes''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is FriendTimes Making Efficient Use Of Its Profits?

FriendTimes has a three-year median payout ratio of 44% (where it is retaining 56% of its income) which is not too low or not too high. So it seems that FriendTimes is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Along with seeing a growth in earnings, FriendTimes only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 29% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we are quite pleased with FriendTimes' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. 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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