Yum China Holdings, Inc.'s (NYSE:YUMC) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Yum China Holdings' (NYSE:YUMC) recent performance, when its stock has declined 15% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Yum China Holdings' 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.

View our latest analysis for Yum China Holdings

How Is ROE Calculated?

The formula for ROE is:

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

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

14% = US$895m ÷ US$6.6b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.14 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. 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.

Yum China Holdings' Earnings Growth And 14% ROE

At first glance, Yum China Holdings seems to have a decent ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 19%. On further research, we found that Yum China Holdings' net income growth of 3.2% over the past five years is quite low. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. Hence there might be some other aspects that are keeping growth in earnings low. These include low earnings retention or poor capital allocation.

We then compared Yum China Holdings' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 26% in the same 5-year period, which is a bit concerning.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for YUMC? You can find out in our latest intrinsic value infographic research report.

Is Yum China Holdings Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 27% (implying that the company retains the remaining 73% of its income), Yum China Holdings' earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Yum China Holdings has paid dividends over a period of seven years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 28% of its profits over the next three years. Accordingly, forecasts suggest that Yum China Holdings' future ROE will be 15% which is again, similar to the current ROE.

Conclusion

Overall, we feel that Yum China Holdings certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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