Most readers would already be aware that China Tobacco International (HK)'s (HKG:6055) stock increased significantly by 18% over the past month.   Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes.      Specifically, we decided to study China Tobacco International (HK)'s  ROE in this article.  

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital.  Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

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 Tobacco International (HK) is:

26% = HK$692m ÷ HK$2.7b (Based on the trailing twelve months to December 2023).

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$0.26 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.  Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits.  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.

China Tobacco International (HK)'s Earnings Growth And 26% ROE

Firstly, we acknowledge that China Tobacco International (HK) has a significantly high ROE.   Secondly, even when compared to the industry average of 4.7% the company's ROE is quite impressive.   Probably as a result of this, China Tobacco International (HK) was able to see a decent net income growth of 20% over the last five years.    

Next, on comparing China Tobacco International (HK)'s net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 20% over the last few years.  

SEHK:6055 Past Earnings Growth March 12th 2024

Earnings growth is an important metric to consider when valuing a stock.   The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in.  Doing so will help them establish if the stock's future looks promising or ominous.    One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if China Tobacco International (HK) is trading on a high P/E or a low P/E, relative to its industry.  

Is China Tobacco International (HK) Efficiently Re-investing Its Profits?

In China Tobacco International (HK)'s case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 23% (or a retention ratio of 77%), which suggests that the company is investing most of its profits to grow its business.  

Moreover, China Tobacco International (HK) is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend.      Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 33% over the next three years.   Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.    

Conclusion  

Overall, we are quite pleased with China Tobacco International (HK)'s performance.      Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth.       With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down.     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.