Is Weakness In Winson Holdings Hong Kong Limited (HKG:8421) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Winson Holdings Hong Kong's (HKG:8421) recent performance, when its stock has declined 4.3% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Winson Holdings Hong Kong's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Winson Holdings Hong Kong

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Winson Holdings Hong Kong is:

19% = HK$23m ÷ HK$125m (Based on the trailing twelve months to December 2019).

The 'return' is the profit over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.19.

Why Is ROE Important For Earnings Growth?

So far, we've learnt 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 Winson Holdings Hong Kong's Earnings Growth And 19% ROE

To start with, Winson Holdings Hong Kong's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to Winson Holdings Hong Kong's decent 12% net income growth seen over the past five years.

Next, on comparing Winson Holdings Hong Kong's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 13% in the same period.

Earnings growth is a huge factor in stock valuation. 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. 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 Winson Holdings Hong Kong is trading on a high P/E or a low P/E, relative to its industry.

Is Winson Holdings Hong Kong Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 47% (implying that the company retains 53% of its profits), it seems that Winson Holdings Hong Kong is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

While Winson Holdings Hong Kong has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Summary

In total, we are pretty happy with Winson Holdings Hong Kong's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Winson Holdings Hong Kong by visiting our risks dashboard for free on our platform here.

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This article by Simply Wall St is general in nature. 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. Thank you for reading.