Should Weakness in Shenzhen Zhilai Sci and Tech Co., Ltd.'s (SZSE:300771) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Simply Wall St · Apr 21, 2023 19:40

Shenzhen Zhilai Sci and Tech (SZSE:300771) has had a rough three months with its share price down 14%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Shenzhen Zhilai Sci and Tech's ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Shenzhen Zhilai Sci and Tech

How Is ROE Calculated?

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 Zhilai Sci and Tech is:

13% = CN¥259m ÷ CN¥2.0b (Based on the trailing twelve months to September 2022).

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¥0.13 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. 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. 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 Zhilai Sci and Tech's Earnings Growth And 13% ROE

At first glance, Shenzhen Zhilai Sci and Tech seems to have a decent ROE. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. Yet, Shenzhen Zhilai Sci and Tech has posted measly growth of 3.1% over the past five years. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared Shenzhen Zhilai Sci and Tech's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same period, which is a bit concerning.

past-earnings-growth — SZSE:300771 Past Earnings Growth April 21st 2023

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Shenzhen Zhilai Sci and Tech fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shenzhen Zhilai Sci and Tech Efficiently Re-investing Its Profits?

Shenzhen Zhilai Sci and Tech has a low three-year median payout ratio of 25% (meaning, the company keeps the remaining 75% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this fact. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Shenzhen Zhilai Sci and Tech has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

In total, it does look like Shenzhen Zhilai Sci and Tech has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 2 risks we have identified for Shenzhen Zhilai Sci and Tech by visiting our risks dashboard for free on our platform here.

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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.