Riverine China Holdings (HKG:1417) has had a great run on the share market with its stock up by a significant 18% over the last month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Riverine China Holdings' ROE in this article.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Riverine China Holdings is:
8.5% = CN¥20m ÷ CN¥240m (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.09 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learnt 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. 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.
Riverine China Holdings' Earnings Growth And 8.5% ROE
At first glance, Riverine China Holdings' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 11%. But then again, Riverine China Holdings' five year net income shrunk at a rate of 10%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.
However, when we compared Riverine China Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.8% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Riverine China Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Riverine China Holdings Efficiently Re-investing Its Profits?
Riverine China Holdings' low three-year median payout ratio of 16% (or a retention ratio of 84%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.
In addition, Riverine China Holdings only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.
On the whole, we feel that the performance shown by Riverine China Holdings can be open to many interpretations. 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 4 risks we have identified for Riverine China Holdings visit our risks dashboard for free.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.