Are Robust Financials Driving The Recent Rally In Tencent Holdings Limited's (HKG:700) Stock?

Tencent Holdings (HKG:700) has had a great run on the share market with its stock up by a significant 31% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Tencent Holdings' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How Is ROE Calculated?

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 Tencent Holdings is:

19% = CN¥196b ÷ CN¥1.1t (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.19 in profit.

Check out our latest analysis for Tencent Holdings

What Is The Relationship Between ROE And 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 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.

Tencent Holdings' Earnings Growth And 19% ROE

To begin with, Tencent Holdings seems to have a respectable ROE. Especially when compared to the industry average of 7.6% the company's ROE looks pretty impressive. This certainly adds some context to Tencent Holdings' decent 6.0% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Tencent Holdings compares quite favourably to the industry average, which shows a decline of 6.7% over the last few years.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 700? You can find out in our latest intrinsic value infographic research report.

Is Tencent Holdings Efficiently Re-investing Its Profits?

Tencent Holdings' three-year median payout ratio to shareholders is 11% (implying that it retains 89% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Tencent Holdings 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 is expected to rise to 19% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, we are pretty happy with Tencent Holdings' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.