CDL Hospitality Trusts' (SGX:J85) stock up by 5.8% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. In this article, we decided to focus on CDL Hospitality Trusts' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for CDL Hospitality Trusts

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 CDL Hospitality Trusts is:

4.1% = S$68m ÷ S$1.6b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.04.

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. 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 CDL Hospitality Trusts' Earnings Growth And 4.1% ROE

On the face of it, CDL Hospitality Trusts' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 6.9% either. For this reason, CDL Hospitality Trusts' five year net income decline of 37% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 1.3% in the same period, we found that CDL Hospitality Trusts' performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is J85 worth today? The intrinsic value infographic in our free research report helps visualize whether J85 is currently mispriced by the market.

Is CDL Hospitality Trusts Using Its Retained Earnings Effectively?

CDL Hospitality Trusts has a very high three-year median payout ratio of 91%, implying that it retains only 8.7% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. Accordingly, this likely explains why its earnings have been shrinking.

In addition, CDL Hospitality Trusts 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 112% over the next three years. Still, forecasts suggest that CDL Hospitality Trusts' future ROE will rise to 5.0% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

Overall, we would be extremely cautious before making any decision on CDL Hospitality Trusts. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.