The Hong Kong and China Gas Company Limited's (HKG:3) Stock Financial Prospects Look Bleak: Should Shareholders Be Prepared For A Share Price Correction?

Most readers would already know that Hong Kong and China Gas' (HKG:3) stock increased by 5.0% over the past month. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Particularly, we will be paying attention to Hong Kong and China Gas' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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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 Hong Kong and China Gas is:

9.9% = HK$6.8b ÷ HK$68b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.10 in profit.

View our latest analysis for Hong Kong and China Gas

What Has ROE Got To Do With 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. 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.

Hong Kong and China Gas' Earnings Growth And 9.9% ROE

On the face of it, Hong Kong and China Gas' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.1%. But Hong Kong and China Gas saw a five year net income decline of 3.3% over the past five years. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

As a next step, we compared Hong Kong and China Gas' performance with the industry and found thatHong Kong and China Gas' performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 1.6% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. 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. Is 3 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Hong Kong and China Gas Making Efficient Use Of Its Profits?

With a three-year median payout ratio as high as 119%,Hong Kong and China Gas' shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 96% of its profits over the next three years. As a result, Hong Kong and China Gas' ROE is not expected to change by much either, which we inferred from the analyst estimate of 12% for future ROE.

Conclusion

Overall, we would be extremely cautious before making any decision on 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.