Guangzhou Baiyun International Airport (SHSE:600004) has had a rough three months with its share price down 5.3%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Guangzhou Baiyun International Airport's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Guangzhou Baiyun International Airport is:

3.5% = CN¥629m ÷ CN¥18b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.03.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Guangzhou Baiyun International Airport's Earnings Growth And 3.5% ROE

It is hard to argue that Guangzhou Baiyun International Airport's ROE is much good in and of itself. Even compared to the average industry ROE of 6.3%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 43% seen by Guangzhou Baiyun International Airport over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Guangzhou Baiyun International Airport's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.9% in the same 5-year period.

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. Is 600004 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Guangzhou Baiyun International Airport Making Efficient Use Of Its Profits?

Looking at its LTM (or last twelve month) payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, Guangzhou Baiyun International Airport's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Guangzhou Baiyun International Airport has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 33%. However, Guangzhou Baiyun International Airport's ROE is predicted to rise to 6.7% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we feel that the performance shown by Guangzhou Baiyun International Airport 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com