China YuHua Education (HKG:6169) had a tough three months with a 34% drop in its share price. But if you pay close attention, you might realize that its strong financials could mean the stock could potentially see a long-term rise in value, as the markets generally reward companies in good financial health. In this article, we decided to focus on the ROE of China YuHua Education.
Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
See our latest analysis for China YuHua Education
How do you calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for China YuHua Education is:
45% = CN¥1.7b ÷ CN¥3.8b (based on trailing 12 months to August 2021).
The “return” is the annual profit. So this means that for every HK$1 investment of its shareholder, the company generates a profit of HK$0.45.
What does ROE have to do with earnings growth?
We have already established that ROE serves as an effective earnings-generating indicator for a company’s future earnings. Depending on how much of these earnings the company reinvests or “keeps”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
Revenue growth and ROE of 45% from China YuHua Education
For starters, China YuHua Education has quite a high ROE, which is interesting. Additionally, the company’s ROE is above the industry average of 9.8%, which is quite remarkable. Under these circumstances, China YuHua Education’s five-year net income growth of 27% was to be expected.
As a next step, we benchmarked China YuHua Education’s net income growth with the industry, and fortunately, we found that the growth the company saw was higher than the industry average growth of 15%.
The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. 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 will help them determine if the future of the title looks bright or ominous. 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. Thus, you might want to check whether China YuHua Education is trading on a high P/E or a low P/E, relative to its industry.
Does China YuHua Education effectively reinvest its profits?
Although the company has paid a portion of its dividend in the past, it currently does not pay any dividend. This is probably what explains the strong earnings growth discussed above.
Overall, we are quite satisfied with the performance of China YuHua Education. Specifically, we like that the company reinvests a large portion of its earnings at a high rate of return. This of course caused the company to see substantial growth in profits. That said, a study of the latest analyst forecasts shows that the company should see a slowdown in future earnings growth. To learn more about the latest analyst forecasts for the company, check out this analyst forecast visualization for the company.
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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.