It is hard to get excited after looking at Kinco Automation (Shanghai)Ltd's (SHSE:688160) recent performance, when its stock has declined 24% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Kinco Automation (Shanghai)Ltd'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.

How To 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 Kinco Automation (Shanghai)Ltd is:

7.6% = CN¥58m ÷ CN¥764m (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.08.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

Kinco Automation (Shanghai)Ltd's Earnings Growth And 7.6% ROE

On the face of it, Kinco Automation (Shanghai)Ltd's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.3%. On the other hand, Kinco Automation (Shanghai)Ltd reported a fairly low 4.8% net income growth over the past five years. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.

As a next step, we compared Kinco Automation (Shanghai)Ltd's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 6.4% in the same period.

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Kinco Automation (Shanghai)Ltd is trading on a high P/E or a low P/E, relative to its industry.

Is Kinco Automation (Shanghai)Ltd Efficiently Re-investing Its Profits?

While Kinco Automation (Shanghai)Ltd has a decent three-year median payout ratio of 37% (or a retention ratio of 63%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Kinco Automation (Shanghai)Ltd has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we have mixed feelings about Kinco Automation (Shanghai)Ltd. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard will have the 1 risk we have identified for Kinco Automation (Shanghai)Ltd.

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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.