How Did China Electronics Huada Technology Company Limited's (HKG:85) 8.1% ROE Fare Against The Industry?

I am writing today to help inform people who are new to the stock market and want to begin learning the link between company’s fundamentals and stock market performance.

With an ROE of 8.1%, China Electronics Huada Technology Company Limited (HKG:85) returned in-line to its own industry which delivered 7.2% over the past year. However, whether this ROE is actually impressive depends on if it can be maintained. Sustainability can be gauged by a company’s financial leverage – the more debt it has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden. Let me show you what I mean by this.

Check out our latest analysis for China Electronics Huada Technology

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) is a measure of China Electronics Huada Technology’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Semiconductors sector by choosing the highest returning stock. However, this can be misleading as each firm has different costs of equity and debt levels i.e. the more debt China Electronics Huada Technology has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.

ROE is measured against cost of equity in order to determine the efficiency of China Electronics Huada Technology’s equity capital deployed. Its cost of equity is 14.9%. Given a discrepancy of -6.8% between return and cost, this indicated that China Electronics Huada Technology may be paying more for its capital than what it’s generating in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from China Electronics Huada Technology’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at China Electronics Huada Technology’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 120%, which is relatively proportionate and indicates China Electronics Huada Technology has not taken on extreme leverage. Thus, we can conclude its above-average ROE is generated from its capacity to increase profit without a massive debt burden.

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. China Electronics Huada Technology’s ROE is impressive relative to the industry average, though its returns were not strong enough to cover its own cost of equity. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For China Electronics Huada Technology, I've put together three important factors you should look at:

1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does China Electronics Huada Technology's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of China Electronics Huada Technology? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.