Yum China Holdings, Inc.'s (NYSE:YUMC) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Most readers would already be aware that Yum China Holdings' (NYSE:YUMC) stock increased significantly by 8.3% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Yum China Holdings' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Yum China Holdings

How Is ROE Calculated?

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 Yum China Holdings is:

11% = US$812m ÷ US$7.2b (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.11.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Yum China Holdings' Earnings Growth And 11% ROE

At first glance, Yum China Holdings seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 17% does temper our expectations. On further research, we found that Yum China Holdings' net income growth of 5.0% 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. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that Yum China Holdings' reported growth was lower than the industry growth of 19% over the last few years, which is not something we like to see.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is YUMC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Yum China Holdings Using Its Retained Earnings Effectively?

Yum China Holdings has a low three-year median payout ratio of 24% (meaning, the company keeps the remaining 76% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Yum China Holdings has been paying dividends over a period of six years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 25%. However, Yum China Holdings' ROE is predicted to rise to 17% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we do feel that Yum China Holdings has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.