Most readers would already be aware that Kinetic Development Group's (HKG:1277) stock increased significantly by 23% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Kinetic Development Group's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Kinetic Development Group is:

33% = CN¥2.6b ÷ CN¥7.9b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.33 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Kinetic Development Group's Earnings Growth And 33% ROE

First thing first, we like that Kinetic Development Group has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 10% which is quite remarkable. As a result, Kinetic Development Group's exceptional 24% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing Kinetic Development Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 27% over the last few years.

Earnings growth is a huge factor in stock valuation. 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. One 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 prospects. So, you may want to check if Kinetic Development Group is trading on a high P/E or a low P/E, relative to its industry.

Is Kinetic Development Group Using Its Retained Earnings Effectively?

Kinetic Development Group's three-year median payout ratio is a pretty moderate 33%, meaning the company retains 67% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Kinetic Development Group is reinvesting its earnings efficiently.

Additionally, Kinetic Development Group has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we are quite pleased with Kinetic Development Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard will have the 1 risk we have identified for Kinetic Development Group.

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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.