Most readers would already be aware that United Faith Auto-Engineering's (SZSE:301112) stock increased significantly by 12% over the past week. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study United Faith Auto-Engineering's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for United Faith Auto-Engineering
How Do You 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 United Faith Auto-Engineering is:
5.3% = CN¥66m ÷ CN¥1.2b (Based on the trailing twelve months to June 2023).
The 'return' refers to a company's earnings over the last year. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.05.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of United Faith Auto-Engineering's Earnings Growth And 5.3% ROE
When you first look at it, United Faith Auto-Engineering's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.8% either. Therefore, it might not be wrong to say that the five year net income decline of 4.9% seen by United Faith Auto-Engineering was probably the result of it having a lower ROE. 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.
However, when we compared United Faith Auto-Engineering's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. 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. 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 United Faith Auto-Engineering is trading on a high P/E or a low P/E, relative to its industry.
Is United Faith Auto-Engineering Using Its Retained Earnings Effectively?
United Faith Auto-Engineering has a high three-year median payout ratio of 81% (that is, it is retaining 19% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for United Faith Auto-Engineering by visiting our risks dashboard for free on our platform here.
Additionally, United Faith Auto-Engineering 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
On the whole, United Faith Auto-Engineering's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Up till now, we've only made a short study of the company's growth data. You can do your own research on United Faith Auto-Engineering 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.