It is hard to get excited after looking at Yum China Holdings’ (NYSE:YUMC) recent performance, when its stock has declined 6.4% over the past month. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Yum China Holdings’ ROE today.
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 Yum China Holdings
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 Yum China Holdings is:
13% = US$901m ÷ US$7.1b (Based on the trailing twelve months to December 2023).
The ‘return’ is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.13 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. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. 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.
Yum China Holdings’ Earnings Growth And 13% ROE
At first glance, Yum China Holdings seems to have a decent ROE. Be that as it may, the company’s ROE is still quite lower than the industry average of 17%. On further research, we found that Yum China Holdings’ net income growth of 2.8% over the past five years is quite low. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. Hence there might be some other aspects that are keeping growth in earnings low. Such as, the company pays out a huge portion of its earnings as dividends, or is facing competitive pressures.
We then compared Yum China Holdings’ net income growth with the industry and found that the company’s growth figure is lower than the average industry growth rate of 22% in the same 5-year period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for YUMC? You can find out in our latest intrinsic value infographic research report.
Is Yum China Holdings Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 26% (or a retention ratio of 74% over the past three years, Yum China Holdings has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company’s business may be deteriorating.
Additionally, Yum China Holdings has paid dividends over a period of six years, which means that the company’s management is determined to pay dividends even if it means little to no 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 26%. Regardless, the future ROE for Yum China Holdings is predicted to rise to 15% despite there being not much change expected in its payout ratio.
Conclusion
Overall, we feel that Yum China Holdings certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at the current analyst estimates, we found that the company’s earnings are expected to gain momentum. 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.
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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.
