China Airlines, Ltd.'s (TWSE:2610) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Most readers would already be aware that China Airlines' (TWSE:2610) stock increased significantly by 21% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study China Airlines' ROE in this article.

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.

View our latest analysis for China Airlines

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for China Airlines is:

12% = NT$9.5b ÷ NT$80b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each NT$1 of shareholders' capital it has, the company made NT$0.12 in profit.

Why Is ROE Important For 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

China Airlines' Earnings Growth And 12% ROE

At first glance, China Airlines seems to have a decent ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 21%. That being the case, the significant five-year 44% net income growth reported by China Airlines comes as a pleasant surprise. Therefore, there could be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the high earnings growth seen by the company.

We then compared China Airlines' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same 5-year period.

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). Doing so will help them establish if the stock's future looks promising or ominous. Is China Airlines fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is China Airlines Using Its Retained Earnings Effectively?

China Airlines' three-year median payout ratio is a pretty moderate 49%, meaning the company retains 51% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like China Airlines is reinvesting its earnings efficiently.

Besides, China Airlines has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 60% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 5.7%, over the same period.

Summary

In total, we are pretty happy with China Airlines' performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com