Most readers would already be aware that TS Wonders Holding's (HKG:1767) stock increased significantly by 37% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on TS Wonders Holding's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for TS Wonders Holding

How Do You Calculate Return On Equity?

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 TS Wonders Holding is:

5.6% = S$2.9m ÷ S$52m (Based on the trailing twelve months to December 2019).

The 'return' is the income the business earned 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$0.06 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learnt that ROE is a measure of a company's profitability. 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.

TS Wonders Holding's Earnings Growth And 5.6% ROE

When you first look at it, TS Wonders Holding's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 9.8%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 26% seen by TS Wonders Holding over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared TS Wonders Holding's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 8.7% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 TS Wonders Holding is trading on a high P/E or a low P/E, relative to its industry.

Is TS Wonders Holding Using Its Retained Earnings Effectively?

TS Wonders Holding doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Summary

On the whole, we feel that the performance shown by TS Wonders Holding can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth.

Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business.

To know the 4 risks we have identified for TS Wonders Holding visit our risks dashboard for free.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.