Autohome (NYSE:ATHM) has had a great run on the share market with its stock up by a significant 14% over the last 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 Autohome's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Autohome

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Autohome is:

6.2% = CN¥1.5b ÷ CN¥24b (Based on the trailing twelve months to September 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.06 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. 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.

Autohome's Earnings Growth And 6.2% ROE

At first glance, Autohome's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.4% either. As a result, Autohome's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 20% 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. What is ATHM worth today? The intrinsic value infographic in our free research report helps visualize whether ATHM is currently mispriced by the market.

Is Autohome Efficiently Re-investing Its Profits?

Autohome has a low three-year median payout ratio of 20% (or a retention ratio of 80%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.

Additionally, Autohome has paid dividends over a period of three years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. 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 19%. As a result, Autohome's ROE is not expected to change by much either, which we inferred from the analyst estimate of 7.0% for future ROE.

Summary

On the whole, we feel that the performance shown by Autohome 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. 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.