Sinotruk (Hong Kong)'s (HKG:3808) stock is up by a considerable 5.0% over the past week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Sinotruk (Hong Kong)'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 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 Sinotruk (Hong Kong) is:

14% = CN¥6.8b ÷ CN¥48b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.14 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. 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.

Sinotruk (Hong Kong)'s Earnings Growth And 14% ROE

To start with, Sinotruk (Hong Kong)'s ROE looks acceptable. Even when compared to the industry average of 12% the company's ROE looks quite decent. As you might expect, the 2.6% net income decline reported by Sinotruk (Hong Kong) is a bit of a surprise. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared Sinotruk (Hong Kong)'s growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is 3808 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sinotruk (Hong Kong) Making Efficient Use Of Its Profits?

Looking at its three-year median payout ratio of 48% (or a retention ratio of 52%) which is pretty normal, Sinotruk (Hong Kong)'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. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Sinotruk (Hong Kong) 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 is expected to keep paying out approximately 53% of its profits over the next three years. Accordingly, forecasts suggest that Sinotruk (Hong Kong)'s future ROE will be 16% which is again, similar to the current ROE.

Summary

In total, it does look like Sinotruk (Hong Kong) has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.