Most readers would already be aware that Canggang Railway's (HKG:2169) stock increased significantly by 45% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Canggang Railway's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for Canggang Railway
How Is ROE Calculated?
Return on equity 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:
6.7% = CN¥53m ÷ CN¥801m (Based on the trailing twelve months to June 2024).
The 'return' is the amount earned after tax over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.07 in profit.
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 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.
Canggang Railway's Earnings Growth And 6.7% ROE
On the face of it, Canggang Railway's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 6.7%, we may spare it some thought. But then again, Canggang Railway's five year net income shrunk at a rate of 3.9%. 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, when we compared with the industry, which has shrunk its earnings at a rate of 2.4% in the same 5-year period, we still found Canggang Railway's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Making Efficient Use Of Its Profits?
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. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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. To know the 1 risk we have identified for Canggang Railway visit our risks dashboard for free.
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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.