Is HK Electric Investments and HK Electric Investments Limited's (HKG:2638) Stock On A Downtrend As A Result Of Its Poor Financials?

It is hard to get excited after looking at HK Electric Investments and HK Electric Investments' (HKG:2638) recent performance, when its stock has declined 2.7% over the past month. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to HK Electric Investments and HK Electric Investments' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for HK Electric Investments and HK Electric Investments

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 HK Electric Investments and HK Electric Investments is:

5.1% = HK$2.4b ÷ HK$48b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. 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 Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of HK Electric Investments and HK Electric Investments' Earnings Growth And 5.1% ROE

At first glance, HK Electric Investments and HK Electric Investments' 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 6.8% either. For this reason, HK Electric Investments and HK Electric Investments' five year net income decline of 7.9% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 6.3% in the same period, we still found HK Electric Investments and HK Electric Investments' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

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). 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 HK Electric Investments and HK Electric Investments''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is HK Electric Investments and HK Electric Investments Making Efficient Use Of Its Profits?

HK Electric Investments and HK Electric Investments' very high three-year median payout ratio of 115% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. You can see the 2 risks we have identified for HK Electric Investments and HK Electric Investments by visiting our risks dashboard for free on our platform here.

Additionally, HK Electric Investments and HK Electric Investments has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 107%. Accordingly, forecasts suggest that HK Electric Investments and HK Electric Investments' future ROE will be 5.5% which is again, similar to the current ROE.

Summary

On the whole, HK Electric Investments and HK Electric Investments' performance is quite a big let-down. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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