Fanhua Inc.'s (NASDAQ:FANH) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

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It is hard to get excited after looking at Fanhua’s (NASDAQ:FANH) recent performance, when its stock has declined 3.1% over the past week. 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. In this article, we decided to focus on Fanhua’s ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Fanhua

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity

So, based on the above formula, the ROE for Fanhua is:

17% = CN¥333m ÷ CN¥2.0b (Based on the trailing twelve months to June 2021).

The ‘return’ is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.17.

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.

Fanhua’s Earnings Growth And 17% ROE

At first glance, Fanhua seems to have a decent ROE. Further, the company’s ROE compares quite favorably to the industry average of 11%. However, we are curious as to how the high returns still resulted in flat growth for Fanhua in the past five years. Therefore, there could be some other aspects that could potentially be preventing the company from growing. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by12% in the same period.

past-earnings-growth

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. What is FANH worth today? The intrinsic value infographic in our free research report helps visualize whether FANH is currently mispriced by the market.

Is Fanhua Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 82% (implying that the company keeps only 18% of its income) of its business to reinvest into its business), most of Fanhua’s profits are being paid to shareholders, which explains the absence of growth in earnings.

Moreover, Fanhua has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 78%. However, Fanhua’s ROE is predicted to rise to 23% despite there being no anticipated change in its payout ratio.

Summary

In total, it does look like Fanhua has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. 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.

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.

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