Hangzhou Hota M&E Holdings Co., Ltd.'s (SZSE:001225) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Simply Wall St · 10/15 23:42

Most readers would already be aware that Hangzhou Hota M&E Holdings' (SZSE:001225) stock increased significantly by 13% 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 Hangzhou Hota M&E Holdings' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Hangzhou Hota M&E Holdings

How Do You Calculate Return On Equity?

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 Hangzhou Hota M&E Holdings is:

6.1% = CN¥85m ÷ CN¥1.4b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Hangzhou Hota M&E Holdings' Earnings Growth And 6.1% ROE

On the face of it, Hangzhou Hota M&E Holdings' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.0%. But Hangzhou Hota M&E Holdings saw a five year net income decline of 4.5% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Hangzhou Hota M&E Holdings' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.7% over the last few years.

past-earnings-growth
SZSE:001225 Past Earnings Growth October 15th 2024

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). 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 Hangzhou Hota M&E Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Hangzhou Hota M&E Holdings Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 41% (that is, a retention ratio of 59%), the fact that Hangzhou Hota M&E Holdings' earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Only recently, Hangzhou Hota M&E Holdings stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Summary

On the whole, we feel that the performance shown by Hangzhou Hota M&E Holdings can be open to many interpretations. 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. To know the 2 risks we have identified for Hangzhou Hota M&E Holdings visit our risks dashboard for free.