It is hard to get excited after looking at MTR's (HKG:66) recent performance, when its stock has declined 4.7% over the past three months. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study MTR's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for MTR

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 MTR is:

5.4% = HK$9.7b ÷ HK$180b (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.05 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

MTR's Earnings Growth And 5.4% ROE

At first glance, MTR's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 7.0%. Therefore, it might not be wrong to say that the five year net income decline of 29% seen by MTR was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

As a next step, we compared MTR's performance with the industry and found thatMTR's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 11% in the same period, which is a slower than the company.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about MTR's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is MTR Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 57% (implying that 43% of the profits are retained), most of MTR's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, MTR has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 57%. Still, forecasts suggest that MTR's future ROE will rise to 8.3% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, MTR's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.