Is Weakness In Changhong Jiahua Holdings Limited (HKG:3991) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 2.5% over the past week, it is easy to disregard Changhong Jiahua Holdings (HKG:3991). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Changhong Jiahua 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.

View our latest analysis for Changhong Jiahua Holdings

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 Changhong Jiahua Holdings is:

14% = HK$275m ÷ HK$1.9b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.14.

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. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Changhong Jiahua Holdings' Earnings Growth And 14% ROE

To start with, Changhong Jiahua Holdings' ROE looks acceptable. Especially when compared to the industry average of 7.7% the company's ROE looks pretty impressive. This certainly adds some context to Changhong Jiahua Holdings' decent 8.5% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Changhong Jiahua Holdings' growth is quite high when compared to the industry average growth of 3.7% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Changhong Jiahua Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Changhong Jiahua Holdings Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 30% (implying that the company retains 70% of its profits), it seems that Changhong Jiahua Holdings is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Changhong Jiahua Holdings has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

Overall, we are quite pleased with Changhong Jiahua Holdings' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 4 risks we have identified for Changhong Jiahua Holdings visit our risks dashboard for free.

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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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