With its stock down 2.5% over the past week, it is easy to disregard Old Chang Kee (Catalist:5ML). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Old Chang Kee's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Old Chang Kee
How Is ROE Calculated?
ROE 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 Old Chang Kee is:
22% = S$12m ÷ S$53m (Based on the trailing twelve months to September 2024).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.22 in profit.
What Has ROE Got To Do With 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Old Chang Kee's Earnings Growth And 22% ROE
To start with, Old Chang Kee's ROE looks acceptable. Especially when compared to the industry average of 7.4% the company's ROE looks pretty impressive. This probably laid the ground for Old Chang Kee's significant 22% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Old Chang Kee's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 16%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Old Chang Kee is trading on a high P/E or a low P/E, relative to its industry.