With its stock down 5.1% over the past three months, it is easy to disregard Geely Automobile Holdings (HKG:175). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Geely Automobile Holdings' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Geely Automobile Holdings

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 Geely Automobile Holdings is:

5.7% = CN¥4.6b ÷ CN¥81b (Based on the trailing twelve months to June 2023).

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$0.06 in profit.

What Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of Geely Automobile Holdings' Earnings Growth And 5.7% ROE

At first glance, Geely Automobile Holdings' ROE doesn't look very promising. Next, when compared to the average industry ROE of 7.8%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 24% seen by Geely Automobile Holdings over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared Geely Automobile Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.

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. Is 175 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Geely Automobile Holdings Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 36% (that is, a retention ratio of 64%), the fact that Geely Automobile Holdings' earnings have shrunk is quite puzzling. 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 35%. However, Geely Automobile Holdings' ROE is predicted to rise to 12% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we're a bit ambivalent about Geely Automobile Holdings' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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.