Most readers would already be aware that BYD's (HKG:1211) stock increased significantly by 17% over the past three months.   We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes.      Specifically, we decided to study BYD'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.  In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 BYD is:

9.5% = CN¥11b ÷ CN¥113b (Based on the trailing twelve months to September 2022).

The 'return' refers to a company's earnings over the last year.  Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits.  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 BYD's Earnings Growth And 9.5% ROE

When you first look at it, BYD's ROE doesn't look that attractive.   Yet, a closer study shows that the company's ROE is similar to the industry average of 9.5%.   Even so, BYD has shown a fairly decent growth in its net income which grew at a rate of 12%.  Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth.  For instance, the company has a low payout ratio or is being managed efficiently.    

When you consider the fact that the industry earnings have shrunk at a rate of 0.8% in the same period, the company's net income growth is pretty remarkable.  

SEHK:1211 Past Earnings Growth January 12th 2023

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.   This then helps them determine if the stock is placed for a bright or bleak future.    Is 1211 fairly valued? This infographic on the company's intrinsic value  has everything you need to know.  

Is BYD Making Efficient Use Of Its Profits?  

In BYD's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 10% (or a retention ratio of 90%), which suggests that the company is investing most of its profits to grow its business.  

Besides, BYD has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders.      Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 18% over the next three years.   Still, forecasts suggest that BYD's future ROE will rise to 23% 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  

On the whole, we do feel that BYD has some positive attributes.      Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business.       That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings.  

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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.