China Tourism Group Duty Free (SHSE:601888) has had a great run on the share market with its stock up by a significant 11% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to China Tourism Group Duty Free's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for China Tourism Group Duty Free is:

10% = CN¥6.2b ÷ CN¥60b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.10 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

China Tourism Group Duty Free's Earnings Growth And 10% ROE

When you first look at it, China Tourism Group Duty Free's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 4.3% doesn't go unnoticed by us. Yet, China Tourism Group Duty Free has posted measly growth of 3.9% over the past five years. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to stay low.

When you consider the fact that the industry earnings have shrunk at a rate of 7.6% in the same 5-year period, the company's net income growth is pretty remarkable.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is 601888 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is China Tourism Group Duty Free Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 34% (implying that the company retains the remaining 66% of its income), China Tourism Group Duty Free's earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, China Tourism Group Duty Free has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 45% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

On the whole, we feel that China Tourism Group Duty Free's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.