HIT Welding IndustryLtd (SZSE:301137) has had a rough three months with its share price down 26%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to HIT Welding IndustryLtd's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 HIT Welding IndustryLtd is:
4.8% = CN¥63m ÷ CN¥1.3b (Based on the trailing twelve months to September 2023).
The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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 HIT Welding IndustryLtd's Earnings Growth And 4.8% ROE
It is hard to argue that HIT Welding IndustryLtd's ROE is much good in and of itself. Not just that, even compared to the industry average of 7.5%, the company's ROE is entirely unremarkable. For this reason, HIT Welding IndustryLtd's five year net income decline of 11% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
That being said, we compared HIT Welding IndustryLtd's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is HIT Welding IndustryLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is HIT Welding IndustryLtd Efficiently Re-investing Its Profits?
Despite having a normal three-year median payout ratio of 25% (where it is retaining 75% of its profits), HIT Welding IndustryLtd has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Only recently, HIT Welding IndustryLtd stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.
Conclusion
Overall, we have mixed feelings about HIT Welding IndustryLtd. 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 HIT Welding IndustryLtd 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.