Are Poor Financial Prospects Dragging Down The Hong Kong and China Gas Company Limited (HKG:3 Stock?

It is hard to get excited after looking at Hong Kong and China Gas' (HKG:3) recent performance, when its stock has declined 5.0% over the past three months. 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 Hong Kong and China Gas' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Hong Kong and China Gas

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 Hong Kong and China Gas is:

9.4% = HK$6.4b ÷ HK$68b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.09.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Hong Kong and China Gas' Earnings Growth And 9.4% ROE

At first glance, Hong Kong and China Gas' ROE doesn't look very promising. However, its ROE is similar to the industry average of 8.4%, so we won't completely dismiss the company. Having said that, Hong Kong and China Gas' five year net income decline rate was 6.8%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 1.1% over the last few years, we found that Hong Kong and China Gas' performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Hong Kong and China Gas''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hong Kong and China Gas Using Its Retained Earnings Effectively?

Hong Kong and China Gas' high three-year median payout ratio of 119% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. Our risks dashboard should have the 2 risks we have identified for Hong Kong and China Gas.

Moreover, Hong Kong and China Gas 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 89% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 12%, over the same period.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Hong Kong and China Gas. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. 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. 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.