China Modern Dairy Holdings (HKG: 1117) stock rose 18% in the past month. Given the company’s impressive performance, we decided to take a closer look at its financial metrics, as a company’s long-term financial health usually dictates market results. In particular, we will be paying close attention to the ROE of China Modern Dairy Holdings today.
Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.
Check out our latest review for China Modern Dairy Holdings
How do you calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) Ã· Equity
Thus, based on the above formula, the ROE of China Modern Dairy Holdings is:
11% = CN Â¥ 1.1b Ã· CN Â¥ 9.7b (based on the last twelve months up to June 2021).
The “return” is the income the business has earned over the past year. This means that for every HK $ 1 worth of equity, the company generated HK $ 0.11 in profit.
What does ROE have to do with profit growth?
We have already established that ROE is an effective indicator of profit generation for a company’s future profits. We now need to assess how much profit the company is reinvesting or “holding back” for future growth, which then gives us an idea of ââthe growth potential of the company. Generally speaking, all other things being equal, companies with high return on equity and high profit retention have a higher growth rate than companies that do not share these attributes.
China Modern Dairy Holdings profit growth and 11% ROE
For starters, the ROE of China Modern Dairy Holdings seems acceptable. And comparing with the industry, we found that the industry average ROE is similar at 12%. This certainly adds some context to China Modern Dairy Holdings’ exceptional 64% net profit growth seen over the past five years. We believe there could be other factors at play here as well. For example, the business has a low payout ratio or is managed efficiently.
As a next step, we compared the net income growth of China Modern Dairy Holdings with the industry, and luckily we found that the growth observed by the company is higher than the industry average growth of 9.6 %.
Profit growth is an important metric to consider when valuing a stock. What investors next need to determine is whether the expected earnings growth, or lack thereof, is already built into the share price. This then helps them determine whether the stock is set for a bright or dark future. A 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 outlook. So, you might want to check whether China Modern Dairy Holdings is trading high P / E or low P / E, relative to its industry.
Is China Modern Dairy Holdings Using Profits Efficiently?
China Modern Dairy Holdings’ three-year median payout ratio is less than 14%, which means it retains a higher percentage (86%) of its profits. This suggests that management is reinvesting most of the profits to grow the business, as evidenced by the growth seen by the business.
In addition, China Modern Dairy Holdings is committed to continuing to share its profits with its shareholders, which we can deduce from its long history of seven years of paying dividends. Our latest analyst data shows that the company’s future payout ratio over the next three years is expected to be around 12%. However, China Modern Dairy Holdings’ ROE is expected to increase to 17% despite no expected change in its payout ratio.
Overall, we are quite satisfied with the performance of China Modern Dairy Holdings. Specifically, we like the fact that the company reinvests a large portion of its profits at a high rate of return. This of course allowed the company to experience substantial growth in profits. That said, the company’s earnings growth is expected to slow, as current analyst estimates predict. Are the expectations of these analysts based on general industry expectations or on company fundamentals? Click here to go to our business analyst forecasts page.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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