China Tower (HKG:788) has had a great run on the share market with its stock up by a significant 11% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on China Tower's ROE.

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 China Tower

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 China Tower is:

5.4% = CN¥11b ÷ CN¥196b (Based on the trailing twelve months to September 2024).

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.

What Is The Relationship Between ROE And 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 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.

A Side By Side comparison of China Tower's Earnings Growth And 5.4% ROE

On the face of it, China Tower's ROE is not much to talk about. However, its ROE is similar to the industry average of 5.7%, so we won't completely dismiss the company. Having said that, China Tower has shown a modest net income growth of 15% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared China Tower'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 4.4%.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about China Tower's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is China Tower Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 61% (or a retention ratio of 39%) for China Tower suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, China Tower has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders. 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 68%. However, China Tower's ROE is predicted to rise to 7.9% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we do feel that China Tower has some positive attributes. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.