Could The Market Correct MTR’s Share Price?

MTR (HKG:66) has had a great run on the share market with its stock up by a significant 22% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study MTR’s ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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:

6.6% = HK$12b ÷ HK$178b (Based on the trailing twelve months to June 2022).

The ‘return’ is the yearly profit. That means that for every HK$1 worth of shareholders’ equity, the company generated HK$0.07 in profit.

Why Is ROE Important For 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.

MTR’s Earnings Growth And 6.6% ROE

On the face of it, MTR’s ROE is not much to talk about. However, given that the company’s ROE is similar to the average industry ROE of 7.7%, we may spare it some thought. But MTR saw a five year net income decline of 27% over the past five years. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 1.7% in the same period, we found that MTR’s performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

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). Doing so will help them establish if the stock’s future looks promising or ominous. What is 66 worth today? The intrinsic value infographic in our free research report helps visualize whether 66 is currently mispriced by the market.

Is MTR Efficiently Re-investing Its Profits?

MTR’s declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 77% (or a retention ratio of 23%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

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. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 50% over the next three years. As a result, the expected drop in MTR’s payout ratio explains the anticipated rise in the company’s future ROE to 9.0%, over the same period.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning MTR. 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. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company’s earnings growth rate. 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.