Guangdong Investment Limited's (HKG:270) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Guangdong Investment (HKG:270) has had a great run on the share market with its stock up by a significant 17% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Guangdong Investment's ROE today.

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 Guangdong Investment

How To Calculate Return On Equity?

Return on equity 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:

11% = HK$5.4b ÷ HK$50b (Based on the trailing twelve months to September 2020).

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$0.11 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Guangdong Investment's Earnings Growth And 11% ROE

To begin with, Guangdong Investment seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 9.4%. Despite the moderate return on equity, Guangdong Investment has posted a net income growth of 4.2% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Guangdong Investment's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 10% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 270 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Guangdong Investment Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 72% (or a retention ratio of 28%), most of Guangdong Investment's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

In addition, Guangdong Investment has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 69% of its profits over the next three years. Still, forecasts suggest that Guangdong Investment's future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we feel that Guangdong Investment certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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