With its stock down 18% over the past month, it is easy to disregard Canggang Railway (HKG:2169). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Canggang Railway's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Canggang Railway
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 Canggang Railway is:
7.6% = CN¥59m ÷ CN¥775m (Based on the trailing twelve months to December 2023).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.08 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Canggang Railway's Earnings Growth And 7.6% ROE
When you first look at it, Canggang Railway's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.9%. But Canggang Railway saw a five year net income decline of 3.2% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.
Next, we compared Canggang Railway's performance against the industry and found that the industry shrunk its earnings at 5.2% in the same period, which suggests that the company's earnings have been shrinking at a slower rate than its industry, This does appease the negative sentiment around the company to a certain extent.
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. If you're wondering about Canggang Railway's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Canggang Railway Using Its Retained Earnings Effectively?
Looking at its three-year median payout ratio of 41% (or a retention ratio of 59%) which is pretty normal, Canggang Railway's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Canggang Railway has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.
Conclusion
Overall, we have mixed feelings about Canggang Railway. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 3 risks we have identified for Canggang Railway by visiting our risks dashboard for free on our platform here.
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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