China Mengniu Dairy's (HKG:2319) stock is up by a considerable 24% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to China Mengniu Dairy's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for China Mengniu Dairy

How To 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 China Mengniu Dairy is:

13% = CN¥5.6b ÷ CN¥44b (Based on the trailing twelve months to June 2022).

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$0.13 in profit.

What Has ROE Got To Do With 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.

China Mengniu Dairy's Earnings Growth And 13% ROE

To start with, China Mengniu Dairy's ROE looks acceptable. On comparing with the average industry ROE of 8.7% the company's ROE looks pretty remarkable. This certainly adds some context to China Mengniu Dairy's exceptional 26% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared China Mengniu Dairy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.3%.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is 2319 worth today? The intrinsic value infographic in our free research report helps visualize whether 2319 is currently mispriced by the market.

Is China Mengniu Dairy Efficiently Re-investing Its Profits?

China Mengniu Dairy's ' three-year median payout ratio is on the lower side at 21% implying that it is retaining a higher percentage (79%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Additionally, China Mengniu Dairy has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 29% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Summary

In total, we are pretty happy with China Mengniu Dairy's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.