Shanghai Karon Eco-Valve Manufacturing (SZSE:301151) has had a great run on the share market with its stock up by a significant 25% over the last week. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Shanghai Karon Eco-Valve Manufacturing's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 Shanghai Karon Eco-Valve Manufacturing is:

4.7% = CN¥99m ÷ CN¥2.1b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.05 in profit.

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. 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. 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.

Shanghai Karon Eco-Valve Manufacturing's Earnings Growth And 4.7% ROE

It is hard to argue that Shanghai Karon Eco-Valve Manufacturing's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.9%, the company's ROE is entirely unremarkable. For this reason, Shanghai Karon Eco-Valve Manufacturing's five year net income decline of 15% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Shanghai Karon Eco-Valve Manufacturing'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 9.6% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Shanghai Karon Eco-Valve Manufacturing's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shanghai Karon Eco-Valve Manufacturing Efficiently Re-investing Its Profits?

Looking at its three-year median payout ratio of 37% (or a retention ratio of 63%) which is pretty normal, Shanghai Karon Eco-Valve Manufacturing's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Shanghai Karon Eco-Valve Manufacturing only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.

Summary

Overall, we have mixed feelings about Shanghai Karon Eco-Valve Manufacturing. 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. You can see the 3 risks we have identified for Shanghai Karon Eco-Valve Manufacturing by visiting our risks dashboard for free on our platform here.

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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.