Most readers would already be aware that PAX Global Technology's (HKG:327) stock increased significantly by 40% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study PAX Global Technology's ROE in this article.
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.
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 PAX Global Technology is:
14% = HK$686m ÷ HK$5.0b (Based on the trailing twelve months to June 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.14 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
PAX Global Technology's Earnings Growth And 14% ROE
At first glance, PAX Global Technology seems to have a decent ROE. Especially when compared to the industry average of 7.8% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for PAX Global Technology in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
We then compared PAX Global Technology's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 3.7% in the same period, which is a bit concerning.
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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about PAX Global Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is PAX Global Technology Making Efficient Use Of Its Profits?
PAX Global Technology has a low three-year median payout ratio of 18% (or a retention ratio of 82%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.
In addition, PAX Global Technology has been paying dividends over a period of five 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 is expected to keep paying out approximately 21% of its profits over the next three years. However, PAX Global Technology's ROE is predicted to rise to 19% despite there being no anticipated change in its payout ratio.
In total, it does look like PAX Global Technology has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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