China Tower Corporation Limited's (HKG:788) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

China Tower (HKG:788) has had a great run on the share market with its stock up by a significant 6.3% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study China Tower's ROE in this article.

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.

See our latest analysis for China Tower

How Do You Calculate Return On Equity?

Return on equity 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 China Tower is:

3.5% = CN¥6.4b ÷ CN¥186b (Based on the trailing twelve months to December 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

China Tower's Earnings Growth And 3.5% ROE

It is quite clear that China Tower's ROE is rather low. An industry comparison shows that the company's ROE is not much different from the industry average of 3.8% either. However, the exceptional 50% net income growth seen by China Tower over the past five years is pretty remarkable. Given the low ROE, it is likely that there could be some other reasons behind this growth as well. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

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

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if China Tower is trading on a high P/E or a low P/E, relative to its industry.

Is China Tower Making Efficient Use Of Its Profits?

China Tower's three-year median payout ratio is a pretty moderate 43%, meaning the company retains 57% of its income. By the looks of it, the dividend is well covered and China Tower is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

While China Tower has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 69% over the next three years. However, China Tower's future ROE is expected to rise to 5.8% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we feel that China Tower certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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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