Is SmarTone Telecommunications Holdings Limited's (HKG:315) Recent Performancer Underpinned By Weak Financials?

SmarTone Telecommunications Holdings (HKG:315) has had a rough month with its share price down 4.6%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on SmarTone Telecommunications 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for SmarTone Telecommunications Holdings

How Do You Calculate Return On Equity?

ROE 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 SmarTone Telecommunications Holdings is:

6.8% = HK$340m ÷ HK$5.0b (Based on the trailing twelve months to June 2020).

The 'return' is the profit 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$0.07 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

SmarTone Telecommunications Holdings' Earnings Growth And 6.8% ROE

When you first look at it, SmarTone Telecommunications Holdings' ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 11%. For this reason, SmarTone Telecommunications Holdings' five year net income decline of 13% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared SmarTone Telecommunications 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 7.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 SmarTone Telecommunications Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is SmarTone Telecommunications Holdings Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 74% (implying that 26% of the profits are retained), most of SmarTone Telecommunications Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.

Additionally, SmarTone Telecommunications Holdings has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 75% of its profits over the next three years. As a result, SmarTone Telecommunications Holdings' ROE is not expected to change by much either, which we inferred from the analyst estimate of 5.9% for future ROE.

Conclusion

Overall, we would be extremely cautious before making any decision on SmarTone Telecommunications Holdings. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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. 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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