Does Guangdong Investment Limited's (HKG:270) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Guangdong Investment (HKG:270) has had a great run on the share market with its stock up by a significant 15% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Guangdong Investment's ROE.

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 Guangdong Investment

How Is ROE Calculated?

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 Guangdong Investment is:

4.4% = HK$2.6b ÷ HK$59b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.04 in profit.

Why Is ROE Important For 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.

Guangdong Investment's Earnings Growth And 4.4% ROE

On the face of it, Guangdong Investment's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 5.8% either. Therefore, it might not be wrong to say that the five year net income decline of 8.6% seen by Guangdong Investment was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

As a next step, we compared Guangdong Investment's performance with the industry and found thatGuangdong Investment's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 4.4% in the same period, which is a slower than the company.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Guangdong Investment is trading on a high P/E or a low P/E, relative to its industry.

Is Guangdong Investment Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 82% (implying that 18% of the profits are retained), most of Guangdong Investment's 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. Our risks dashboard should have the 4 risks we have identified for Guangdong Investment.

Moreover, Guangdong Investment 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.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Guangdong Investment. 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. 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.