Most readers would already be aware that Geely Automobile Holdings' (HKG:175) stock increased significantly by 52% over the past three months. 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 Geely Automobile Holdings' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Geely Automobile Holdings

How Do You Calculate Return On Equity?

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 Geely Automobile Holdings is:

6.2% = CN¥4.4b ÷ CN¥70b (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Geely Automobile Holdings' Earnings Growth And 6.2% ROE

When you first look at it, Geely Automobile Holdings' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 7.7%, we may spare it some thought. But Geely Automobile Holdings saw a five year net income decline of 11% over the past five years. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 5.3% in the same period, we still found Geely Automobile Holdings' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for 175? You can find out in our latest intrinsic value infographic research report.

Is Geely Automobile Holdings Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 30% (or a retention ratio of 70%) which is pretty normal, Geely Automobile Holdings' 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. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Geely Automobile Holdings has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 33% of its profits over the next three years. Still, forecasts suggest that Geely Automobile Holdings' future ROE will rise to 13% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that the performance shown by Geely Automobile Holdings can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.