Shenzhen Investment Holdings Bay Area Development Company Limited's (HKG:737) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Shenzhen Investment Holdings Bay Area Development's (HKG:737) stock is up by a considerable 10% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study Shenzhen Investment Holdings Bay Area Development's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Shenzhen Investment Holdings Bay Area Development

How Do You Calculate Return On Equity?

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 Shenzhen Investment Holdings Bay Area Development is:

8.3% = CN¥647m ÷ CN¥7.8b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.08 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Shenzhen Investment Holdings Bay Area Development's Earnings Growth And 8.3% ROE

When you first look at it, Shenzhen Investment Holdings Bay Area Development's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.7%, so we won't completely dismiss the company. Having said that, Shenzhen Investment Holdings Bay Area Development's five year net income decline rate was 7.7%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

So, as a next step, we compared Shenzhen Investment Holdings Bay Area Development's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.3% over the last few years.

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. What is 737 worth today? The intrinsic value infographic in our free research report helps visualize whether 737 is currently mispriced by the market.

Is Shenzhen Investment Holdings Bay Area Development Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 86% (implying that 14% of the profits are retained), most of Shenzhen Investment Holdings Bay Area Development'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 3 risks we have identified for Shenzhen Investment Holdings Bay Area Development visit our risks dashboard for free.

Moreover, Shenzhen Investment Holdings Bay Area Development has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 100% of its profits over the next three years. Still, forecasts suggest that Shenzhen Investment Holdings Bay Area Development's future ROE will drop to 5.2% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we would be extremely cautious before making any decision on Shenzhen Investment Holdings Bay Area Development. 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. Up till now, we've only made a short study of the company's growth data. To gain further insights into Shenzhen Investment Holdings Bay Area Development's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.