GreenTree Hospitality Group's (NYSE:GHG) stock is up by 2.1% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on GreenTree Hospitality Group's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for GreenTree Hospitality Group is:
11% = CN¥245m ÷ CN¥2.2b (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.11.
What Has ROE Got To Do With 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of GreenTree Hospitality Group's Earnings Growth And 11% ROE
To start with, GreenTree Hospitality Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 9.3%. GreenTree Hospitality Group's decent returns aren't reflected in GreenTree Hospitality Group'smediocre five year net income growth average of 4.4%. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Given that the industry shrunk its earnings at a rate of 5.0% in the same period, the net income growth of the company is quite impressive.
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. Is GHG fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is GreenTree Hospitality Group Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 53% (or a retention ratio of 47%), most of GreenTree Hospitality Group's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.
In addition, GreenTree Hospitality Group only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 17% over the next three years. The fact that the company's ROE is expected to rise to 26% over the same period is explained by the drop in the payout ratio.
On the whole, we feel that GreenTree Hospitality Group's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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. 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.
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