Luk Fook Holdings (International) Limited's (HKG:590) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 9.8% over the past month, it is easy to disregard Luk Fook Holdings (International) (HKG:590). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Luk Fook Holdings (International)'s ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Luk Fook Holdings (International)

How Do You Calculate Return On Equity?

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 Luk Fook Holdings (International) is:

11% = HK$1.3b ÷ HK$12b (Based on the trailing twelve months to March 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$0.11.

What Has ROE Got To Do With 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.

A Side By Side comparison of Luk Fook Holdings (International)'s Earnings Growth And 11% ROE

To start with, Luk Fook Holdings (International)'s ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.5%. Despite this, Luk Fook Holdings (International)'s five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then compared Luk Fook Holdings (International)'s net income growth with the industry and found that the company's growth figure is a bit less than the average industry growth rate of 0.7% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Luk Fook Holdings (International) is trading on a high P/E or a low P/E, relative to its industry.

Is Luk Fook Holdings (International) Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 46% (implying that the company keeps 54% of its income) over the last three years, Luk Fook Holdings (International) has seen a negligible amount of growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Luk Fook Holdings (International) has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. 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 44%. Still, forecasts suggest that Luk Fook Holdings (International)'s future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, it does look like Luk Fook Holdings (International) has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.