Weak Financial Prospects Seem To Be Dragging Down CLP Holdings Limited (HKG:2) Stock

With its stock down 3.2% over the past three months, it is easy to disregard CLP Holdings (HKG:2). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to CLP Holdings' ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for CLP 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 CLP Holdings is:

7.5% = HK$8.6b ÷ HK$113b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.08.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

CLP Holdings' Earnings Growth And 7.5% ROE

When you first look at it, CLP Holdings' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 6.7%, so we won't completely dismiss the company. But then again, CLP Holdings' five year net income shrunk at a rate of 5.2%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 3.6% over the last few years, we found that CLP Holdings' performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is 2 worth today? The intrinsic value infographic in our free research report helps visualize whether 2 is currently mispriced by the market.

Is CLP Holdings Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 92% (implying that 7.8% of the profits are retained), most of CLP Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for CLP Holdings by visiting our risks dashboard for free on our platform here.

Additionally, CLP 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 60% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 11%, over the same period.

Summary

In total, we would have a hard think before deciding on any investment action concerning CLP Holdings. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.