Are Robust Financials Driving The Recent Rally In Chinasoft International Limited's (HKG:354) Stock?

Chinasoft International's (HKG:354) stock is up by a considerable 40% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Chinasoft International's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Chinasoft 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 Chinasoft International is:

11% = CN¥795m ÷ CN¥7.2b (Based on the trailing twelve months to June 2020).

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$0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Chinasoft International's Earnings Growth And 11% ROE

At first glance, Chinasoft International seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 10%. Consequently, this likely laid the ground for the impressive net income growth of 22% seen over the past five years by Chinasoft International. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Chinasoft International's growth is quite high when compared to the industry average growth of 9.7% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Chinasoft International is trading on a high P/E or a low P/E, relative to its industry.

Is Chinasoft International Efficiently Re-investing Its Profits?

Chinasoft International has a really low three-year median payout ratio of 6.2%, meaning that it has the remaining 94% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Besides, Chinasoft International has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 6.5%. However, Chinasoft International's ROE is predicted to rise to 14% despite there being no anticipated change in its payout ratio.

Summary

Overall, we are quite pleased with Chinasoft International's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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