With its stock down 17% over the past three months, it is easy to disregard Shenzhen Han's CNC Technology (SZSE:301200). 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 Shenzhen Han's CNC Technology'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 Shenzhen Han's CNC Technology is:

3.8% = CN¥192m ÷ CN¥5.1b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.04 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Shenzhen Han's CNC Technology's Earnings Growth And 3.8% ROE

It is quite clear that Shenzhen Han's CNC Technology's ROE is rather low. Even compared to the average industry ROE of 7.6%, the company's ROE is quite dismal. Hence, the flat earnings seen by Shenzhen Han's CNC Technology over the past five years could probably be the result of it having a lower ROE.

We then compared Shenzhen Han's CNC Technology's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Shenzhen Han's CNC Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Shenzhen Han's CNC Technology Using Its Retained Earnings Effectively?

Shenzhen Han's CNC Technology's very high three-year median payout ratio of 108% suggests that the company is paying its shareholders more than what it is earning. This does go some way in explaining the negligible earnings growth seen by Shenzhen Han's CNC Technology. Paying a dividend beyond their means is usually not viable over the long term. That's a huge risk in our books. Our risks dashboard should have the 3 risks we have identified for Shenzhen Han's CNC Technology.

In addition, Shenzhen Han's CNC Technology only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Shenzhen Han's CNC Technology. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Shenzhen Han's CNC Technology's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.