AAC Technologies Holdings Inc. (HKG:2018) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

AAC Technologies Holdings (HKG:2018) has had a great run on the share market with its stock up by a significant 16% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on AAC Technologies Holdings' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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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 AAC Technologies Holdings is:

7.6% = CN¥1.8b ÷ CN¥23b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.08 in profit.

Check out our latest analysis for AAC Technologies Holdings

What Has ROE Got To Do With 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.

AAC Technologies Holdings' Earnings Growth And 7.6% ROE

When you first look at it, AAC Technologies Holdings' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.7%, so we won't completely dismiss the company. But then again, AAC Technologies Holdings' five year net income shrunk at a rate of 15%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

That being said, we compared AAC Technologies Holdings' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 0.2% in the same 5-year period.

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. What is 2018 worth today? The intrinsic value infographic in our free research report helps visualize whether 2018 is currently mispriced by the market.

Is AAC Technologies Holdings Efficiently Re-investing Its Profits?

AAC Technologies Holdings' low three-year median payout ratio of 15% (or a retention ratio of 85%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, AAC Technologies Holdings 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 11% over the next three years. The fact that the company's ROE is expected to rise to 12% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we have mixed feelings about AAC Technologies Holdings. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.