Should Weakness in China MeiDong Auto Holdings Limited's (HKG:1268) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 64% over the past three months, it is easy to disregard China MeiDong Auto Holdings (HKG:1268). 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 China MeiDong Auto Holdings' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for China MeiDong Auto Holdings

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for China MeiDong Auto Holdings is:

4.5% = CN¥234m ÷ CN¥5.2b (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.05.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

China MeiDong Auto Holdings' Earnings Growth And 4.5% ROE

When you first look at it, China MeiDong Auto Holdings' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 8.5%, the company's ROE leaves us feeling even less enthusiastic. Although, we can see that China MeiDong Auto Holdings saw a modest net income growth of 11% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared China MeiDong Auto Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 1.0%.

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. Has the market priced in the future outlook for 1268? You can find out in our latest intrinsic value infographic research report.

Is China MeiDong Auto Holdings Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 65% (or a retention ratio of 35%) for China MeiDong Auto Holdings suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, China MeiDong Auto Holdings has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 49% over the next three years. The fact that the company's ROE is expected to rise to 18% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that China MeiDong Auto Holdings has some positive attributes. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.