Ligao FoodsLtd's (SZSE:300973) stock is up by a considerable 18% over the past month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Ligao FoodsLtd's ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Ligao FoodsLtd is:

3.9% = CN¥97m ÷ CN¥2.5b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.04 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Ligao FoodsLtd's Earnings Growth And 3.9% ROE

As you can see, Ligao FoodsLtd's ROE looks pretty weak. Even compared to the average industry ROE of 8.0%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 20% seen by Ligao FoodsLtd over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Ligao FoodsLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 1.6% in the same period. This is quite worrisome.

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 300973 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Ligao FoodsLtd Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 46% (that is, a retention ratio of 54%), the fact that Ligao FoodsLtd's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Ligao FoodsLtd has been paying dividends for three years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 61% over the next three years. Regardless, the future ROE for Ligao FoodsLtd is speculated to rise to 12% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

On the whole, we feel that the performance shown by Ligao FoodsLtd 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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