It is hard to get excited after looking at Shenzhen Han's CNC Technology's (SZSE:301200) recent performance, when its stock has declined 4.5% over the past week. Given that stock prices are usually driven by a company's fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. In this article, we decided to focus on Shenzhen Han's CNC Technology'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.

How To Calculate Return On Equity?

Return on equity 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:

3.1% = CN¥148m ÷ CN¥4.8b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Shenzhen Han's CNC Technology's Earnings Growth And 3.1% ROE

It is hard to argue that Shenzhen Han's CNC Technology's ROE is much good in and of itself. Even compared to the average industry ROE of 6.8%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 15% seen by Shenzhen Han's CNC Technology over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Shenzhen Han's CNC Technology'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 9.5% in the same 5-year period.

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 Shenzhen Han's CNC Technology is trading on a high P/E or a low P/E, relative to its industry.

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

Shenzhen Han's CNC Technology's high three-year median payout ratio of 108% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. To know the 4 risks we have identified for Shenzhen Han's CNC Technology visit our risks dashboard for free.

Additionally, Shenzhen Han's CNC Technology started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.

Summary

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. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Shenzhen Han's CNC Technology 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.