Most readers would already be aware that Xuchang Yuandong Drive ShaftLtd's (SZSE:002406) stock increased significantly by 13% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Particularly, we will be paying attention to Xuchang Yuandong Drive ShaftLtd's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 Xuchang Yuandong Drive ShaftLtd is:
2.3% = CN¥94m ÷ CN¥4.0b (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. 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?
So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.
Xuchang Yuandong Drive ShaftLtd's Earnings Growth And 2.3% ROE
It is hard to argue that Xuchang Yuandong Drive ShaftLtd's ROE is much good in and of itself. Even when compared to the industry average of 8.0%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 24% seen by Xuchang Yuandong Drive ShaftLtd was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared Xuchang Yuandong Drive ShaftLtd'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 6.2% over the last few years.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Xuchang Yuandong Drive ShaftLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Xuchang Yuandong Drive ShaftLtd Making Efficient Use Of Its Profits?
Xuchang Yuandong Drive ShaftLtd has a high three-year median payout ratio of 57% (that is, it is retaining 43% 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. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 4 risks we have identified for Xuchang Yuandong Drive ShaftLtd visit our risks dashboard for free.
In addition, Xuchang Yuandong Drive ShaftLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Conclusion
Overall, we would be extremely cautious before making any decision on Xuchang Yuandong Drive ShaftLtd. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Xuchang Yuandong Drive ShaftLtd 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.