With its stock down 10% over the past week, it is easy to disregard Guangzhou Tongda Auto Electric (SHSE:603390). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to Guangzhou Tongda Auto Electric's ROE today.

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 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 Guangzhou Tongda Auto Electric is:

2.3% = CN¥36m ÷ CN¥1.6b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.02 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Guangzhou Tongda Auto Electric's Earnings Growth And 2.3% ROE

As you can see, Guangzhou Tongda Auto Electric's ROE looks pretty weak. Even when compared to the industry average of 8.2%, the ROE figure is pretty disappointing. For this reason, Guangzhou Tongda Auto Electric's five year net income decline of 48% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Guangzhou Tongda Auto Electric's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.0% over the last few years.

Earnings growth is a huge factor in stock valuation. 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 Guangzhou Tongda Auto Electric is trading on a high P/E or a low P/E, relative to its industry.

Is Guangzhou Tongda Auto Electric Efficiently Re-investing Its Profits?

Guangzhou Tongda Auto Electric has a high three-year median payout ratio of 83% (that is, it is retaining 17% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 2 risks we have identified for Guangzhou Tongda Auto Electric by visiting our risks dashboard for free on our platform here.

Additionally, Guangzhou Tongda Auto Electric has paid dividends over a period of five years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, Guangzhou Tongda Auto Electric's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Guangzhou Tongda Auto Electric and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.