Is Weakness In Chengdu KSW Technologies Co.,Ltd. (SHSE:688283) Stock A Sign That The Market Could Be Wrong Given Its Strong Financial Prospects?

Simply Wall St · Oct 12, 2023 22:18

Chengdu KSW TechnologiesLtd (SHSE:688283) has had a rough three months with its share price down 14%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Chengdu KSW TechnologiesLtd's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Chengdu KSW TechnologiesLtd

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Chengdu KSW TechnologiesLtd is:

10% = CN¥91m ÷ CN¥901m (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Chengdu KSW TechnologiesLtd's Earnings Growth And 10% ROE

At first glance, Chengdu KSW TechnologiesLtd's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 7.1% which we definitely can't overlook. Especially when you consider Chengdu KSW TechnologiesLtd's exceptional 35% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So, there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Chengdu KSW TechnologiesLtd's growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

past-earnings-growth — SHSE:688283 Past Earnings Growth October 13th 2023

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Chengdu KSW TechnologiesLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Chengdu KSW TechnologiesLtd Using Its Retained Earnings Effectively?

Chengdu KSW TechnologiesLtd has a really low three-year median payout ratio of 9.0%, meaning that it has the remaining 91% left over to reinvest into its business. So it looks like Chengdu KSW TechnologiesLtd is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Along with seeing a growth in earnings, Chengdu KSW TechnologiesLtd only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 4.8% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Conclusion

In total, we are pretty happy with Chengdu KSW TechnologiesLtd's performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.