Are Poor Financial Prospects Dragging Down MTR Corporation Limited (HKG:66 Stock?

It is hard to get excited after looking at MTR's (HKG:66) recent performance, when its stock has declined 5.2% over the past three months. 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. Specifically, we decided to study MTR'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.

View our latest analysis for MTR

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for MTR is:

4.5% = HK$8.1b ÷ HK$179b (Based on the trailing twelve months to December 2023).

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$0.05 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. 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.

MTR's Earnings Growth And 4.5% ROE

At first glance, MTR's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 5.7% either. Therefore, it might not be wrong to say that the five year net income decline of 7.3% seen by MTR was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

With the industry earnings declining at a rate of 7.8% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

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). This then helps them determine if the stock is placed for a bright or bleak future. Is MTR fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is MTR Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 82% (implying that 18% of the profits are retained), most of MTR's 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. To know the 2 risks we have identified for MTR visit our risks dashboard for free.

Additionally, MTR 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 52% over the next three years. The fact that the company's ROE is expected to rise to 8.4% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, MTR's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com