Will Weakness in GreenTree Hospitality Group Ltd.'s (NYSE:GHG) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 3.2% over the past three months, it is easy to disregard GreenTree Hospitality Group (NYSE:GHG). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to GreenTree Hospitality Group'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for GreenTree Hospitality Group

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for GreenTree Hospitality Group is:

11% = CN¥240m ÷ CN¥2.2b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.11 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

GreenTree Hospitality Group's Earnings Growth And 11% ROE

To begin with, GreenTree Hospitality Group seems to have a respectable ROE. Especially when compared to the industry average of 8.3% the company's ROE looks pretty impressive. Probably as a result of this, GreenTree Hospitality Group was able to see a decent growth of 6.8% over the last five years.

As a next step, we compared GreenTree Hospitality Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.2%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is GHG worth today? The intrinsic value infographic in our free research report helps visualize whether GHG is currently mispriced by the market.

Is GreenTree Hospitality Group Using Its Retained Earnings Effectively?

While GreenTree Hospitality Group has a three-year median payout ratio of 53% (which means it retains 47% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

While GreenTree Hospitality Group has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 29% over the next three years. As a result, the expected drop in GreenTree Hospitality Group's payout ratio explains the anticipated rise in the company's future ROE to 24%, over the same period.

Summary

Overall, we are quite pleased with GreenTree Hospitality Group's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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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