Tencent Music Entertainment Group's (NYSE:TME) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Tencent Music Entertainment Group (NYSE:TME) has had a rough three months with its share price down 29%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Tencent Music Entertainment Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Tencent Music Entertainment Group

How Is ROE Calculated?

ROE 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 Tencent Music Entertainment Group is:

9.5% = CN¥6.0b ÷ CN¥63b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Tencent Music Entertainment Group's Earnings Growth And 9.5% ROE

At first glance, Tencent Music Entertainment Group's ROE doesn't look very promising. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. Tencent Music Entertainment Group was still able to see a decent net income growth of 10% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Tencent Music Entertainment Group's reported growth was lower than the industry growth of 22% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Tencent Music Entertainment Group is trading on a high P/E or a low P/E, relative to its industry.

Is Tencent Music Entertainment Group Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 30% (implying that the company retains 70% of its profits), it seems that Tencent Music Entertainment Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Our latest analyst data shows that the future payout ratio of the company is expected to drop to 9.8% over the next three years. The fact that the company's ROE is expected to rise to 12% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we do feel that Tencent Music Entertainment Group has some positive attributes. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. 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 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.