Vtech Holdings Limited (HKG:303) Has Fared Decently But Fundamentals Look Uncertain: What Lies Ahead For The Stock?

Vtech Holdings' (HKG:303) stock is up by 4.2% over the past week. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. In this article, we decided to focus on Vtech 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.

See our latest analysis for Vtech Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Vtech Holdings is:

26% = US$161m ÷ US$610m (Based on the trailing twelve months to September 2023).

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$0.26 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. 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.

Vtech Holdings' Earnings Growth And 26% ROE

First thing first, we like that Vtech Holdings has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 3.8% also doesn't go unnoticed by us. For this reason, Vtech Holdings' five year net income decline of 3.6% raises the question as to why the high ROE didn't translate into earnings growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared Vtech Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.3% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Vtech Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Vtech Holdings Making Efficient Use Of Its Profits?

Vtech Holdings has a high three-year median payout ratio of 98% (that is, it is retaining 2.0% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Vtech Holdings.

In addition, Vtech 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 95%. As a result, Vtech Holdings' ROE is not expected to change by much either, which we inferred from the analyst estimate of 28% for future ROE.

Conclusion

In total, we're a bit ambivalent about Vtech Holdings' performance. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Vtech Holdings' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.