Will the weakness in shares of China Tobacco International (HK) Company Limited (HKG:6055) prove temporary given the strong fundamentals?
It’s hard to get excited after watching the recent performance of China Tobacco International (HK) (HKG:6055), as its stock has fallen 34% in the past three months. However, a closer look at his healthy finances might make you think again. Since fundamentals generally determine long-term market outcomes, the company is worth looking into. In this article, we decided to focus on China Tobacco International (HK) DEER.
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 short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.
Our analysis indicates that 6055 is potentially overvalued!
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 China Tobacco International (HK) is:
18% = HK$386 million ÷ HK$2.1 billion (based on trailing 12 months to June 2022).
The “return” is the annual profit. Another way to think about this is that for every HK$1 of equity, the company was able to make a profit of HK$0.18.
Why is ROE important for earnings growth?
We have already established that ROE serves as an effective profit-generating indicator for a company’s future earnings. 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. 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.
Side-by-side comparison of China Tobacco International (HK) 18% earnings and ROE growth
At first glance, China Tobacco International (HK) seems to have a decent ROE. Compared to the industry average ROE of 5.2%, the company’s ROE looks quite remarkable. This certainly adds some context to China Tobacco International’s (HK) outstanding 23% net profit growth seen over the past five years. We believe that there could also be other aspects that positively influence the company’s earnings growth. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio.
We then compared the growth of China Tobacco International (HK) net income with the industry and we are pleased to see that the growth figure of the company is higher than that of the industry which recorded a growth rate 12% over the same period.
Earnings growth is an important factor in stock valuation. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This will help them determine if the future of the title looks bright or ominous. Is China Tobacco International (HK) correctly valued compared to other companies? These 3 recovery measures might help you decide.
Is China Tobacco International (HK) Reinvesting Profits Effectively?
China Tobacco International (HK) has a three-year median payout ratio of 26% (where it retains 74% of its revenue), which is neither too low nor too high. So it looks like China Tobacco International (HK) is effectively reinvesting to see impressive earnings growth (discussed above) and paying a well-covered dividend.
Additionally, China Tobacco International (HK) is determined to continue sharing its profits with shareholders, which we infer from its long three-year history of paying dividends.
Overall, we are quite satisfied with the performance of China Tobacco International (HK). In particular, it is good to see that the company is investing heavily in its business and, along with a high rate of return, this has resulted in significant growth in its profits. If the company continues to increase earnings as it has, it could have a positive impact on its share price given how earnings per share influence prices over the long term. Remember that the price of a stock also depends on the perceived risk. Therefore, investors should be aware of the risks involved before investing in a company. Our risk dashboard will have the 1 risk we have identified for China Tobacco International (HK).
Valuation is complex, but we help make it simple.
Find out if China Tobacco International (HK) is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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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.