It is hard to get excited after looking at Topsports International Holdings' (HKG:6110) recent performance, when its stock has declined 19% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Topsports International Holdings' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

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 Topsports International Holdings is:

18% = CN¥1.7b ÷ CN¥9.5b (Based on the trailing twelve months to August 2024).

The 'return' is the yearly profit. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.18.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Topsports International Holdings' Earnings Growth And 18% ROE

To start with, Topsports International Holdings' ROE looks acceptable. On comparing with the average industry ROE of 8.3% the company's ROE looks pretty remarkable. As you might expect, the 5.3% net income decline reported by Topsports International Holdings is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

So, as a next step, we compared Topsports International Holdings' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 3.6% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Topsports International Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Topsports International Holdings Using Its Retained Earnings Effectively?

Topsports International Holdings has a high three-year median payout ratio of 59% (that is, it is retaining 41% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for Topsports International Holdings visit our risks dashboard for free.

In addition, Topsports International Holdings has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 70%. However, Topsports International Holdings' ROE is predicted to rise to 24% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we do feel that Topsports International Holdings has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.