The share of Haidilao International Holding Ltd. (HKG:6862) has shown weakness lately, but the financial outlook looks decent: is the market wrong?

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Haidilao International Holding (HKG:6862) had a difficult three months with its share price down 27%. However, stock prices are usually determined by a company’s long-term finances, which in this case seem quite respectable. In this article, we decided to focus on the ROE of Haidilao International Holding.

ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In simple terms, it is used to assess the profitability of a company in relation to its equity.

Check out our latest analysis for Haidilao International Holding

How is ROE calculated?

the ROE formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Haidilao International Holding is:

13% = CN¥1.4b ÷ CN¥10b (based on trailing 12 months to June 2021).

The “return” is the annual profit. One way to conceptualize this is that for every HK$1 of share capital it has, the company has made a profit of HK$0.13.

Why is ROE important for earnings growth?

So far, we have learned that ROE measures how efficiently a company generates its profits. Based on the share of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

Haidilao International Holding earnings growth and ROE of 13%

To begin with, the ROE of Haidilao International Holding seems acceptable. Additionally, the company’s ROE compares quite favorably to the industry average of 6.1%. For this reason, Haidilao International Holding’s 5.2% decline in net profit over five years raises the question of why the high ROE has not translated into profit growth. Based on this, we believe that there might be other reasons which have not been discussed so far in this article which might hinder the growth of the business. For example, the company pays a large portion of its profits in the form of dividends or faces competitive pressures.

In a next step, we compared the performance of Haidilao International Holding with the industry and found that the industry declined at a rate of 11% during the same period, which means that the company reduced its profits at a lower rate than the industry. This to some extent alleviates the negative sentiment around the company.

SEHK: 6862 Past Earnings Growth Jan 24, 2022

Earnings growth is an important metric to consider when evaluating a stock. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. This then helps them determine if the stock is positioned for a bright or bleak future. If you’re wondering about the valuation of Haidilao International Holding, check out this indicator of its price/earnings ratio, relative to its sector.

Does Haidilao International Holding make effective use of its retained earnings?

Haidilao International Holding’s low three-year median payout ratio of 20% (or an 80% retention rate) over the past three years should mean the company is retaining most of its earnings to fuel growth, but the company’s profits actually declined. The low payout should mean that the company keeps most of its profits and therefore should see some growth. So there could be other explanations for this. For example, the company’s business may deteriorate.

Moreover, Haidilao International Holding has been paying dividends for three years, which is a considerable length of time, suggesting that management must have perceived that shareholders preferred consistent dividends even though profits had declined. After reviewing the latest analyst consensus data, we found that the company’s future payout ratio is expected to reach 30% over the next three years. Still, forecasts suggest Haidilao International Holding’s future ROE will rise to 24% even though the company’s payout ratio is expected to increase. We speculate that other characteristics of the company could be driving the anticipated growth in the company’s ROE.

Summary

Overall, we think Haidilao International Holding certainly has some positive factors to consider. However, we are disappointed to see a lack of earnings growth, even despite a high ROE and high reinvestment rate. We believe there could be external factors that could negatively impact the business. That being the case, the latest forecasts from industry analysts show that analysts are expecting a huge improvement in the company’s earnings growth rate. Are these analyst expectations based on general industry expectations or company fundamentals? Click here to access our analyst forecast page for the company.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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