Shenzhen Chuangyitong TechnologyLtd (SZSE:300991) has had a great run on the share market with its stock up by a significant 44% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Shenzhen Chuangyitong TechnologyLtd'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 To Calculate Return On Equity?
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 Shenzhen Chuangyitong TechnologyLtd is:
3.0% = CN¥20m ÷ CN¥641m (Based on the trailing twelve months to June 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.03 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Shenzhen Chuangyitong TechnologyLtd's Earnings Growth And 3.0% ROE
It is quite clear that Shenzhen Chuangyitong TechnologyLtd's ROE is rather low. Not just that, even compared to the industry average of 6.4%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 53% seen by Shenzhen Chuangyitong TechnologyLtd over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Shenzhen Chuangyitong TechnologyLtd'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 4.7% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Chuangyitong TechnologyLtd is trading on a high P/E or a low P/E, relative to its industry.
Is Shenzhen Chuangyitong TechnologyLtd Making Efficient Use Of Its Profits?
In spite of a normal three-year median payout ratio of 33% (that is, a retention ratio of 67%), the fact that Shenzhen Chuangyitong TechnologyLtd's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In addition, Shenzhen Chuangyitong TechnologyLtd only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.
Conclusion
Overall, we have mixed feelings about Shenzhen Chuangyitong TechnologyLtd. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. Our risks dashboard would have the 3 risks we have identified for Shenzhen Chuangyitong TechnologyLtd.
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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.
